This document provides an overview of balance sheet analysis and calculating return on capital employed (ROCE). It begins with a sample balance sheet and shows how borrowing can be moved to the "funding" side. It then defines the operating and funding sides, and how the operating side aims to earn a return greater than the weighted average cost of capital. The document demonstrates calculating ROCE and breaking it down further. It also discusses asset turnover and its components. Finally, it provides an example calculation and identifies the main driver of a change in ROCE based on the information given.
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Finance and Business Case Essentials for Product ManagersJeremy Horn
Slides Vikas Batra recently used in his discussion w/ mentees of The Product Mentor.
The Product Mentor is a program designed to pair Product Mentors and Mentees from around the World, across all industries, from start-up to enterprise, guided by the fundamental goals…Better Decisions. Better Products. Better Product People.
Throughout the program, each mentor leads a conversation in an area of their expertise that is live streamed and available to both mentee and the broader product community.
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Watch out full video on Youtube -
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It suggests that the firm value is maximum with right proportion of debt and equity mix
As per this approach, debt funding should exist in the capital structure only up to a certain level, after which, any increase in debt funding would result in the reduction in value of the firm by increasing cost of equity
It advocates that there exists an optimum level of debt and equity at which the WACC is the lowest and the market value of the firm is the highest
Assumptions
There are only two sources of financing – Debt and Equity
The interest rate on debt remains constant to a certain level after which it increases with an increase in debt financing
The expected rate of return on equity increases gradually to a certain level after which it increases speedily with increase in debt because of the financial risk involved
WACC first decreases and then starts increasing with increased interest rate on debt and increased required rate of return on equity
No taxes & transaction cost
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Subscribe to DevTech Finance
BlueBookAcademy.com - Introduction to Business Valuationbluebookacademy
Lets run through the three popular approaches to valuing companies, both private and public. We introduce asset-based, relative and cash flow based valuation methods using case study examples. We discuss the concept of price, value and worth and identify the value drivers financial analysts use to determine value.
Finance and Business Case Essentials for Product ManagersJeremy Horn
Slides Vikas Batra recently used in his discussion w/ mentees of The Product Mentor.
The Product Mentor is a program designed to pair Product Mentors and Mentees from around the World, across all industries, from start-up to enterprise, guided by the fundamental goals…Better Decisions. Better Products. Better Product People.
Throughout the program, each mentor leads a conversation in an area of their expertise that is live streamed and available to both mentee and the broader product community.
http://TheProductMentor.com
Watch out full video on Youtube -
https://youtu.be/VP2ZqqWmUvM
It suggests that the firm value is maximum with right proportion of debt and equity mix
As per this approach, debt funding should exist in the capital structure only up to a certain level, after which, any increase in debt funding would result in the reduction in value of the firm by increasing cost of equity
It advocates that there exists an optimum level of debt and equity at which the WACC is the lowest and the market value of the firm is the highest
Assumptions
There are only two sources of financing – Debt and Equity
The interest rate on debt remains constant to a certain level after which it increases with an increase in debt financing
The expected rate of return on equity increases gradually to a certain level after which it increases speedily with increase in debt because of the financial risk involved
WACC first decreases and then starts increasing with increased interest rate on debt and increased required rate of return on equity
No taxes & transaction cost
Thank you for Watching
Subscribe to DevTech Finance
Weighted average cost is the average of the costs of specific sources of capital employed in a business, properly weighted by the proportion they hold in the firm’s capital structure.
Book Value :
Value shown in the balance sheet is called book value. Weightage to each source of finance is given on the basis of book value as recorded in the balance sheet.
Market Value :
Market value represent prices of prevailing in the stock market for securities. So current market price are applied in ascertaining the weightage.
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Weighted average cost is the average of the costs of specific sources of capital employed in a business, properly weighted by the proportion they hold in the firm’s capital structure.
Book Value :
Value shown in the balance sheet is called book value. Weightage to each source of finance is given on the basis of book value as recorded in the balance sheet.
Market Value :
Market value represent prices of prevailing in the stock market for securities. So current market price are applied in ascertaining the weightage.
CEI Compliance is the UK's fastest growing risk & regulatory consultancy and provides associate opportunities to consultants and cost effective value to financial services and other regulated companies.
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dr Amine Awad in the UAB conference - february 2011 presents views on Reasons behind the International Financial Crisis
Major Components of Basel III
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In this presentation you will be introduced to the “Various Risk Factors in Banking”, which will help you understand the components and types of risk and it’s peril on the banking sector and risk terminologies used in the banking sector.
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This will be used as part of your Personal Professional Portfolio once graded.
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Prepare a presentation or a paper using research, basic comparative analysis, data organization and application of economic information. You will make an informed assessment of an economic climate outside of the United States to accomplish an entertainment industry objective.
Safalta Digital marketing institute in Noida, provide complete applications that encompass a huge range of virtual advertising and marketing additives, which includes search engine optimization, virtual communication advertising, pay-per-click on marketing, content material advertising, internet analytics, and greater. These university courses are designed for students who possess a comprehensive understanding of virtual marketing strategies and attributes.Safalta Digital Marketing Institute in Noida is a first choice for young individuals or students who are looking to start their careers in the field of digital advertising. The institute gives specialized courses designed and certification.
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June 3, 2024 Anti-Semitism Letter Sent to MIT President Kornbluth and MIT Cor...Levi Shapiro
Letter from the Congress of the United States regarding Anti-Semitism sent June 3rd to MIT President Sally Kornbluth, MIT Corp Chair, Mark Gorenberg
Dear Dr. Kornbluth and Mr. Gorenberg,
The US House of Representatives is deeply concerned by ongoing and pervasive acts of antisemitic
harassment and intimidation at the Massachusetts Institute of Technology (MIT). Failing to act decisively to ensure a safe learning environment for all students would be a grave dereliction of your responsibilities as President of MIT and Chair of the MIT Corporation.
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The House of Representatives will not countenance the use of federal funds to indoctrinate students into hateful, antisemitic, anti-American supporters of terrorism. Investigations into campus antisemitism by the Committee on Education and the Workforce and the Committee on Ways and Means have been expanded into a Congress-wide probe across all relevant jurisdictions to address this national crisis. The undersigned Committees will conduct oversight into the use of federal funds at MIT and its learning environment under authorities granted to each Committee.
• The Committee on Education and the Workforce has been investigating your institution since December 7, 2023. The Committee has broad jurisdiction over postsecondary education, including its compliance with Title VI of the Civil Rights Act, campus safety concerns over disruptions to the learning environment, and the awarding of federal student aid under the Higher Education Act.
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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