Formulas and concepts Flashcards
NPV
calculating the net present value of an individual cash flow
NPV = sum{F / [ (1 + i)^n ]} - ii
Lump sum/discount rate= end sum
Where,
PV = Present Value F = Future payment (cash flow) i = Discount rate (or interest rate) n = the number of periods in the future the cash flow is ii = initial investment
A positive net present value indicates that the projected earnings generated by a project or investment (in present dollars) exceeds the anticipated costs (also in present dollars). Generally, an investment with a positive NPV will be profitable, and an investment with a negative NPV will result in a net loss.
Companies often have different ways of identifying the discount rate. Common methods for determining the discount rate include using the expected return of other investment choices with a similar level of risk (rates of return investors will expect), or the costs associated with borrowing money needed to finance the project.
For example, if a retail clothing business wants to purchase an existing store, it would first estimate the future cash flows that store would generate, and then discount those cash flows into one lump-sum present value amount — let’s say $500,000. If the owner of the store were willing to sell his or her business for less than $500,000, the purchasing company would likely accept the offer as it presents a positive NPV investment. If the owner agreed to sell the store for $300,000, then the investment represents a $200,000 net gain ($500,000 - $300,000) during the calculated investment period. This $200,000, or the net gain of an investment, is called the investment’s intrinsic value. Conversely, if the owner would not sell for less than $500,000, the purchaser would not buy the store, as the acquisition would present a negative NPV at that time and would, therefore, reduce the overall value of the larger clothing company.
Read more: Net Present Value (NPV) Definition | Investopedia https://www.investopedia.com/terms/n/npv.asp#ixzz5PTxlP3F5
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Sunk costs
Sunk costs (past costs) are excluded from future business decisions because the cost will be the same regardless of the outcome of a decision.
If, for example, XYZ Clothing is considering shutting down a production facility, any of the sunk costs that have end dates should be included in the decision.
Things to consider when introducing a new product
cannibalization, cross-selling, capacity
Growth references
30% growth is amazing for a commodity industry
Considerations when entering a novel market
First mover advantage
Could lose benefits of economies of scale (net loss of 3.5M in button volume)
Consideration when creating a website
potential to supplant traditional distribution and provide better margins
Working capital
Working capital is a measure of both a company’s operational efficiency and its short-term financial health. The working capital ratio (current assets/current liabilities), or current ratio, indicates whether a company has enough short-term assets to cover its short-term debt. A good working capital ratio is considered anything between 1.2 and 2.0. A ratio of less than 1.0 indicates negative working capital, with potential liquidity problems, while a ratio above 2.0 might indicate that a company is not using its excess assets effectively to generate maximum possible revenue.
P and L
profit and loss statement=Income statement
is a financial statement that summarizes the revenues, costs and expenses incurred during a specified period, usually a fiscal quarter or year.
records the business performance through a period of time. Directly tells you how the company is doing in terms of making money. like a Profits tree
Consideration when downsizing portfolio
Less diversification in products exposes them to increased market risk
up-front investment
If smaller, could be better to enter less attractive market based on growth and size
When lacking the technical capabilities to enter this specialized market
think about an acquisition strategy,
I would recommend going for one of the larger companies, as that would give the client a stronger position. Smaller companies would probably not offer an important enough position in the market.
Engineering 4.0
using the next generation of tools—IoT, AI-aided design, and additive manufacturing—to come up with better design.
risk aversion
Risk averse is the description of an investor who, when faced with two investments with a similar expected return, prefers the one with the lower risk.
risk aversion is the behavior of humans (especially consumers and investors), who, when exposed to uncertainty, attempt to lower that uncertainty
Utilities
Overhead includes all ongoing business expenses not including or related to direct labor or direct materials used in creating a product or service. A company must pay overhead on an ongoing basis, regardless of how much or how little the company is selling
Overhead expenses can be fixed, meaning they are the same amount every time, or variable, meaning they increase or decrease depending on the business’s activity level. For example, a business’s rent payment may be fixed, while shipping and mailing may be variable.
Categorizing Overhead Expenses
Overhead expenses may apply to a variety of operational categories. Administrative overhead traditionally includes costs related to basic administration and general business operations, such as the need for accountants or receptionists. Selling overhead relates to activities involved in marketing. This can include printed materials and television commercials, as well as the salaries of administrative-support professionals.
Depending on the nature of the business, other categories may be appropriate, such as research overhead, maintenance overhead manufacturing overhead or transportation overhead.
fixed cost
A fixed cost is an expense or cost that does not change with an increase or decrease in the number of goods or services produced or sold
Examples of fixed costs include insurance, interest expense, property taxes, utilities expenses and depreciation of assets. Also, if a company pays annual salaries to its employees regardless of the number of hours worked, such salaries are considered fixed costs. A company’s lease on a building is another common example of a fixed cost that can absorb significant funds, especially for retail companies that rent their store premises.
Variable costs per item stay relatively flat, and the total variable costs will change proportionately to the number of product items produced. Fixed costs per item decrease with an increase in production. Thus, a company can achieve economies of scale when it produces enough goods to spread the same amount of fixed costs over a larger number of units produced and sold.
overhead salary(hiring too many/paying too much) rental
variable cost
A variable cost is a corporate expense that changes in proportion with production output.
Examples of variable costs are sales commissions, direct labor costs, cost of raw materials used in production, and utility costs. The formula for variable cost is given as:
Total variable cost = Quantity of output x Variable cost per unit of output.
Economies of scale
Economies of scale refer to reduced costs per unit that arise from increased total output of a product.
Economies of scale give rise to lower per-unit costs for several reasons. First, specialization of labor and more integrated technology boost production volumes. Second, lower per-unit costs can come from bulk orders from suppliers, larger advertising buys or lower cost of capital. Third, spreading internal function costs across more units produced and sold helps to reduce costs. “Internal functions” include accounting, information technology, and marketing. The first two reasons are also considered operational efficiencies and synergies. The second two reasons are cited as benefits of mergers and acquisitions.
Break-even analysis
Break-even analysis entails the calculation and examination of the margin of safety for an entity based on the revenues collected and associated costs. Analyzing different price levels relating to various levels of demand, an entity uses break-even analysis to determine what level of sales are needed to cover total fixed costs.
The calculation of break-even analysis may be performed using two formulas. First, the total fixed costs are divided the unit contribution margin. Alternatively, the break-even point in sales dollars is calculated by dividing total fixed costs by the contribution margin ratio.
Contribution Margin
The concept of break-even analysis deals with the contribution margin of a product. The contribution margin is the excess between the selling price of the good and total variable costs. For example, if a product sells for $100, total fixed costs are $25 per product and total variable costs are $60 per product, the product has a contribution margin of the product is $40 ($100 - $60). This $40 reflects the amount of revenue collected to cover fixed costs and be retained as net profit. Fixed costs are not considered in calculating the contribution margin.
The contribution margin allows management to determine how much revenue and profit can be earned from each unit of product sold. The contribution margin is calculated as:
Contribution Margin = Gross Profit / Sales = (Sales – Variable Costs) / Sales
elasticity
elasticity refers the degree to which individuals, consumers or producers change their demand or the amount supplied in response to price or income changes. It is predominantly used to assess the change in consumer demand as a result of a change in a good or service’s price.
When the value of elasticity is greater than 1, it suggests that the demand for the good or service is affected by the price. A value that is less than 1 suggests that the demand is insensitive to price.
%change in quantity/%change in price
Companies with high elasticity ultimately compete with other businesses on price and are required to have a high volume of sales transactions to remain solvent. Firms that are inelastic, on the other hand, have products and services that are must-haves and enjoy the luxury of setting higher prices.
Beyond prices, the elasticity of a good or service directly affects the customer retention rates of a company. Businesses often strive to sell goods or services that have inelastic demand; doing so means that customers will remain loyal and continue to purchase the good or service even in the face of a price increase.
Balance sheet
A snapshot of the current stage of the company’s property, dept, and ownership at one given point int time. It shows three figures:
assets: what the company owns: buildings equipment cash etc.
-
Liabilities: what the company owes: bills, loans etc.
= equity: networth/book value
The balance sheet is always balanced!
Amortization
Amortization is an accounting technique used to lower the cost value of a finite life or intangible asset incrementally through scheduled charges to income. When businesses amortize expenses, it helps tie the asset’s costs to the revenues it generates. For example, if a company buys a ream of paper, it writes off the cost in the year of purchase and generally uses all the paper the same year. Conversely, with a large asset, the business reaps the rewards of the expense for years. Thus, it writes off the expense incrementally over the useful life of that asset, tangible or intangible.
Amortization is the paying off of debt with a fixed repayment schedule in regular installments over time like with a mortgage or a car loan. It also refers to the spreading out of capital expenses for intangible assets over a specific duration — usually over the asset’s useful life — for accounting and tax purposes.
Depreciation
Depreciation is an accounting method of allocating the cost of a tangible asset over its useful life and is used to account for declines in value. Businesses depreciate long-term assets for both tax and accounting purposes.Depreciation is a “non-cash” expense that reduces the value of an asset over time. When depreciation is non-cash, this means that it is taken as an accounting entry and the amount of cash held by the business is not affected. The business can include a specific amount on its income tax return as an expense during each year of the useful life of the asset.
Depreciation is often a difficult concept for accounting students as it does not represent real cash flow. Depreciation is an accounting convention that allows a company to write off an asset’s value over time, but it is considered a non-cash transaction.For accounting purposes, depreciation expense does not represent a cash transaction, but it shows how much of an asset’s value the business has used over a period. For example, if a company buys a piece of equipment for $50,000, it can either write the entire cost of the asset off in year one or write the value of the asset off over the assets 10-year life. This is why business owners like depreciation. Most business owners prefer to expense only a portion of the cost, which artificially boosts net income. In addition, the company can scrap the equipment for $10,000, which means it has a salvage value of $10,000. Using these variables, the analyst calculates depreciation expense as the difference between the cost of the asset and the salvage value, divided by the useful life of the asset. The calculation in this example is ($50,000 - $10,000) / 10, which is $4,000.
A business owner can choose the straight-line depreciation method, which means that an equal amount of depreciation is recognized each year. If, instead, the owner chooses an accelerated method of depreciation, the company recognizes more depreciation in the early years and less in the later years of the asset’s useful life.One popular method is the double-declining balance (DDB) method, which uses a depreciation rate that is twice is straight-line percentage.
Salvage value
Salvage value is the estimated value that an owner is paid when the item is sold at the end of its useful life and is used to determine annual depreciation.
