Jan - Economics & Financial Reporting Flashcards
What is considered in the triple bottom line?
The triple bottom line (TBL) focuses corporations not just on the economic value they add, but also on the environmental and social value they add – and destroy.
Traditionally organizations measured success solely in terms of an economic bottom line – usually PROFIT
How are aspects of the triple bottom line evaluated?
People (Social Bottom Line)
• Worker happiness
• Good employer
Planet (Environmental Bottom Line)
• “Life Cycle Assessment”
• “Environmental Impact”
• Human health
Profit or Prosperity (Economic Bottom Line)
• Capital and operating costs
• Wealth created
What are CAPEX, OPEX, and TOTEX
CAPEX - investment costs
OPEX - operational costs inc. maintenance
TOTEX - total costs
What are CCFDs?
What do they show?
Cumulative cash flow diagrams.
They represent transactions of cash which will take place over the course of a given project.
- Includes initial investments, operating costs, projected income (from sales), and salvage and resale value of equipment at the end of the project.
- Often used with a breakeven sheet and a balance sheet in order to see where money is being made or lost.
- Can be used to readily show the effect of changing variables on the project cash flow and compare different options.
What are the financial considerations for starting a new project?
Level of Investment
- Land
- Buildings
- Capital Plant & Equipment
Annual Operating Costs
- Production costs (e.g. operators, raw materials, energy)
- Marketing costs (Sales team, advertising, exhibitions
Income
- Income, derived from Sales Revenue
Profit
Calculated for each year:
Profit = Income – Operating Costs
Tax
Paid each year on profit made, after deducting:
Depreciation tax allowances
Net Cash Flow (after tax)
Calculated from the above
What are the 8 steps for a systematic approach to the economic evaluation of projects?
Step 1 - Calculate capital tax allowances
Step 2 - Calculate trading profits
Step 3 - Calculate taxable profits
Step 4 - Calculate tax receivable or payable
Step 5 - Calculate net cash flow after tax
Step 6 - Apply discount factor
Step 7 - Calculate present value of net cash flow
Step 8 - Apply chosen method of economic evaluation
What is capital tax allowance a.k.a?
Depreciation tax allowance (not the same as depreciation of assets)
In the UK, allowances are applied to:
• Process Plant & Equipment
• Buildings (method depends on use)
• Land (normally excluded)
What is capital tax allowance?
A.k.a depreciation tax allowance
It is tax relief on tangible capital expenditure, allowing it to be expensed against its annual pre-tax income.
If you buy an asset, for example, machinery or other equipment for use in your business, you cannot deduct your expenditure on that asset from your trading profits. Instead, you may be able to claim a capital allowance for that expenditure.
The aim is to give tax relief for the reduction in value of qualifying assets by letting you write off their cost over time against the taxable income of your business.
It’s a mechanism to pay less tax in the first years of a project. The government is stimulating investment, thus creating jobs and boosting the economy.
What does NBV stand for?
Net book value.
Also known as net asset value, is the value at which a company reports an asset on its balance sheet. It is calculated as the original cost of an asset less accumulated depreciation, accumulated amortization, accumulated depletion or accumulated impairment.
What is net book value?
Also known as net asset value, is the value at which a company reports an asset on its balance sheet. It is calculated as the original cost of an asset less accumulated depreciation, accumulated amortization, accumulated depletion or accumulated impairment.
Book value is equal to the cost of carrying an asset on a company’s balance sheet, and firms calculate it netting the asset against its accumulated depreciation. As a result, book value can also be thought of as the net asset value (NAV) of a company, calculated as its total assets minus intangible assets (patents, goodwill) and liabilities.
How are trading profits calculated?
Trading profit = income - operating costs
Additional important factors:
• Tax payable features in the next step.
• If we gain extra money from the sale of a Capital Asset this features as extra income.
• Therefore, this is added to our income calculations as we have to pay tax on this gain (none in this example).
• If we incur additional tax allowable costs (for tax calculation) at the end of project e.g. disposal of old plant & equipment (£20k in Year 5), then this is added to our operating costs in that year.
• On the calculation sheet – incomes are positive and expenditures (costs) are negative.
How is tax allowance used?
Tax allowance is subtracted from profit.
The remaining value is the taxable profit, which you must pay tax on.
What is tax payable?
How is it considered?
Tax which you must pay.
As the tax is normally payable in the ‘year following’ that in which the profit was earned, the amount of tax payable (or receivable) is entered one year forward in our Cash Flow calculations.
• Hence it is necessary to add an extra year in our table (year n+1), to allow for this ‘year following’ principle.
• Note: in reality, tax is often paid either in anticipation of a profit being made.
How is the discount factor found?
= 1/ (1 + i/100)^n
Where:
i is the % internal rate of return (IRR)
n is the year for which the discount factor is calculated
How do we select a suitable IRR (internal return rate)?
This is based on the normal level of return a company can expect to make from their investments. In our model:
• the IRR excludes any allowance for inflation,
• it allows for the payment of tax (IRR rate after paying tax).
Note: methods of calculation will vary between companies. Some may use a ‘before tax IRR’, and the calculation is adjusted.
How is present value calculated?
PV = V(1/(1 + IRR)^n)
Where:
V I’d net cash flow after tax
IRR is the internal rate of return rate
n is the year for which the discount fa toe is calculated
What is IRR?
Internal return rate.
IRR is the discount rate at which the present value of all future cash flow is equal to the initial investment or,
in other words, the rate at which an investment breaks even.
As a minimum:
i. IRR > (Savings Bank Rate – allowance for inflation)
Note: In our current financial crisis this would be a silly number.
ii. A higher IRR may be set to reflect the level of risk associated with the project.
iii. A higher IRR may be selected, to reflect high return investment opportunities e.g. overseas activities.
What are the 3 main methods of economic evaluation?
1) Payback or break-even method
2) NPV method applying IRR to reflect the company’s after tax cost of capital
3) IRR method
What does the payback or break-even method (regarding economic evaluation in a cash flow calculation) consider?
A fixed value of IRR is selected, and the number of years in which it takes for the cumulative PV to reach a value = 0, is calculated.
The project with shortest payback period would appear most attractive, but it would not necessarily be selected (as other factors are also considered).
What does the NPV method (regarding economic evaluation in a cash flow calculation) consider?
A fixed value of IRR is selected, and the NPV for each project is calculated.
The project with the highest NPV would appear most attractive, but it would not necessarily be selected (as other factors are also considered).
A project with a negative NPV is unlikely to be selected (unless there are other strategic reasons e.g. safety requirement).
What does the IRR method (regarding economic evaluation in a cash flow calculation) consider?
The NPV is calculated for different values of the IRR searching for a value of IRR such that the NPV = 0.
The project with the highest IRR would appear most attractive, but it would not necessarily be selected (as other factors are also considered).
What are CAPEX and OPEX?
- Capital expenditure (CAPEX)
* Operational expenditure (OPEX)
What must be considered when examining project costs?
CAPEX (captial expenditure) OPEX (operational expenditure) Cumulative cash flow Life cycle cost Whole life cost Total cost of ownership TOTEX
How does a cumulative cash flow (vs time) diagram vary with increasing interest rate?
The gradient of the line of the production stages becomes steeper.
What are the different stages of the cumulative cash flow (vs time) diagram?
(A to H)
A-B: Development and design. CCF is negative since money is spent on development.
B-C: Capital investment
in buildings, land,
plant, etc. CCF is negative.
C-D: Working capital and plant
commissioning. CCF is negative and typically at its lowest point (assuming profits are made effectively in the future).
D-E: The plant starts to operate and some money is made. CCF is negative (but the line gradient is positive)
E-F: Profits are made and CCF increases. Point F (on the x axis) is the break-even point.
F-G: CCF is positive and profits are above costs.
G-H: Period when income decreases
and/or costs increase. Income slows but CCF is typically positive.
What can be done to consider the uncertainties that arise with a cumulative cash flow diagram?
Don’t stop with total cost of ownership (TCO) at the decision point.
Continue monitoring the condition of assets and updating the total costs (engineering asset management).
What is involved in asset management?
The consideration of asset capability and cost. Physical and financial models are produced to do so.
What are the key elements of asset management?
- Alignment of assets and operations with corporate objectives
- Asset management is about obtaining the knowledge
needed to optimise trade-offs among financial performance, operational performance and risk exposure - Life-cycle costing is a key concept: Costs are minimized, starting with the initial investment, continuing through operation and maintenance, and ending with disposal
- It is a process: To understand asset management, we need to identify and define the activities involved. Asset management is about designing and implementing a new business process that can deliver higher returns
What is considered in TCO (total costs of ownership)?
Preparation, design, establishment, administrative Capital costs Maintenance Operation Revenues and/or cost savings Tax Financial risks of failure All converted to a net present value
Give examples of users of financial information and how they use it:
Competitors: competitive analysis studies to look at market share
Customers: ability to provide regular, reliable supply of goods, assessment of customer dependence
Government: VAT and corporate taxation
Lenders: capacity and ability to service debt and repay capital
Employees: potential for providing continued employment
Managers / directors: aid decision making
Shareholders / investors: maintain a check on how effectively the company is run and to assess financial strength and future developments
How do a cash flow sheet, balance, and profit and loss statements differ?
Cash flow - considers cash received and cash paid per time period (e.g. money in and out that week)
Profit and loss aka income statement - specifically considers money made and lost
Balance - considers assets, liabilities, equity. This links to the cash flow and income statements
Balance Sheet
• Financial snapshot at a moment in time.
• Main elements: Assets; Liabilities; and Equity.
Profit & Loss Account
• Shows the change in wealth of the business over accounting period.
• It measures the change in the balance sheet from one point to another.
Cash Flow Statement
• Cash is a crucial requirement for any business to develop.
• Term cash also covers: deposits, overdrafts, etc.
What is the prudence concept?
Revenue and profits are not anticipated, but only included when realised, or cash realisation can be assessed with reasonable certainty.
Do not overestimate revenues or underestimate expenses. Be conservative in the reporting of assets and liabilities.
Provisions for liabilities and expenses are made on information available rather than just guesses.
Companies should record losses as soon as they are known, and profits only when they have actually been received.
What is the accruals concept?
Revenue and costs are recognised as they are earned or incurred, are matched with one another and are dealt with in the PLA in the period to which they relate,
irrespective of the receipt or payment.
Revenues and costs are recognised as they are earned or incurred, and are dealt with in the income statement of the period to which they relate, irrespective of the period of receipt or payment.
When transactions are recorded in the books of accounts as they occur even if the payment for that particular product or service has not been received or made, it is known as accrual based accounting.
What is the consistency concept?
We have uniformity of accounting treatment of like items within accounting periods or from one period to the next.
What are some of the main elements of a profit and loss account? (9)
Turnover Cost of sales Distribution costs Administration costs Other income Finance income Finance costs Taxation Dividends
What do costs of sales include?
Cost of sales covers direct costs of goods sold plus any manufacturing expenses relating to the sales or costs of goods sold.
E.g. cost of raw materials, packing costs etc.
What do distribution costs include?
Distribution costs covers the cost of selling and delivering goods and services
What do admin costs include?
All other costs not covered in costs of sales, distribution costs, or financial costs.
