Strategy and Management Class 1 PDF

Strategy and management Class 1 What is a company?  WHAT IS A COMPANY What is a company? 2  WHAT IS A COMPANY A company may be defined as a voluntary association where two or more persons co...

Strategy and management Class 1 What is a company?  WHAT IS A COMPANY What is a company? 2  WHAT IS A COMPANY A company may be defined as a voluntary association where two or more persons come together to carry on activities for a common business goal. It is a commercial organization that operates on a for-profit basis and participates in selling goods or services to customers. A company is an entity that has a separate legal existence from its owners. The owners of the company are known as members or shareholders. Its legal status gives a company the same rights as a natural person which means that a company can incur debt, sue and be sued. 3 WHAT IS A COMPANY A company is a form of business organization, that could even be a: association foundation network an organized group of persons, (incorporated or not) …. 4  WHAT IS A COMPANY Company objectives 1. Maximisation of sales revenue 2. Maximisation of profit 3. Maximisation of investments (return on capital employed) 4. Survive over time 5. Long-term stability 6. Growth 7. Satisfying people 8. Enhancement/maximisation of the wealth of the business 5 THE INPUT-OUTPUT MODEL External environment THE FIRM Input Activities Output Financial Resources Management Organization Competitive Institutional Accounting 6  RESOURCES Equity Primary Labour Resources Technical & industrial properties Other Commercial properties... 7  ACTIVITIES How do companies work? 8 ACTIVITIES Management activities Run the business Organization activities Organize the business Accounting activities Record the business 9 ACTIVITIES - MANAGEMENT What does it mean to manage a company? 10  ACTIVITIES - MANAGEMENT Management Strategic Management Operative Management The set of managerial decisions and The set of managerial decisions and actions that determines the long-run actions that determines the performance of a corporation. It performance of a daily activity and includes: short-term performance. It includes: environmental analysis (internal & Purchasing external) Operations strategy formulation (planning) Sales strategy implementation evaluation and control 11 ACTIVITIES - ORGANIZATION What does it mean to organize a company? 12  ACTIVITIES – ORGANIZATION How relevant are the people? How relevant is “organizing organizations”? 13  ACTIVITIES – ORGANIZATION Easy to organize Difficult to organize 14  ACTIVITIES – ORGANIZATION Organizing involves creating a structure of relationship among people working for the desired results”. Organizing means: Determining, grouping and structuring the activities Creating rules for effective performance at work. Allocation necessary authority and responsibility. Determining detailed procedures and systems regarding coordination, communication motivation etc. 15  ACTIVITIES – ORGANIZATION Company organization follows company values 16 ACTIVITIES – ORGANIZATION "Our people are our single greatest strength and most enduring longterm competitive advantage." Gary Kelly, CEO Southwest Airlines 17 ACTIVITIES - ACCOUNTING What are accounting activities? 18 ACTIVITIES - ACCOUNTING Accounting is the language of a business Account Explain Accounting Explanations 19  ACTIVITIES - ACCOUNTING What accounting is: Accounting is a service activity which “provides quantitative information, primarily financial in nature, about economic entities that is intended to be useful in making economic decisions, in making resolved choice among alternative courses of action”. Accounting Principles Board, Statement N° 4, New York, American Institute of Certified Public Accountants (AICPA) 1970 “Accounting is the art of recording, classifying and summarizing in a significant manner and in terms of money, transactions and events which are, in part at least, of a financial character, and interpreting the result thereof”. “Review and Resume”, Accounting Terminology Bulletin N° 1, American Institute of Certified Public Accountants (AICPA) 1970 “Accounting is the process of identifying, measuring and communicating information to permit informed judgments and decisions by users of the information”. A Statement of Basic Accounting Theory, 1996 20  ACTIVITIES - ACCOUNTING TO SUM UP: Accounting is an organized way of measuring and summarizing the information - mainly quantitative and financial in nature - related to the activities of business. The users of accounting information rely on accounting information to make decisions. 21  ACTIVITIES - ACCOUNTING Accounting is an organized way of summarizing the activities of a business. Internal and external users of accounting information rely on accounting information to make decisions. Internal Users External Users Owners Lenders Managers Potential shareholders Officers Governments Internal Auditors Labor Unions Sales Staff External Auditors Budget Officers Customers … … 22  ACTIVITIES - ACCOUNTING Investors base investment decisions and estimate the value of stock using accounting information. Recent accounting scandals has shaken the confidence of investors in financial markets. ENRON – Bankruptcy of one of the largest U.S. firms due to financial statement misrepresentation involving the external auditor (Arthur Andersen), management, and financial partners including Merrill Lynch, Citigroup, CIBC and others Other accounting/investment scandals involving WorldCom, Tyco, Parmalat and others demonstrate that the ENRON issue was not an isolated incident. 23  OUTPUT How can we measure company’s performance? 24  OUTPUT KPI Profit Financial It measures the firm’s Financial performance capability to be profitable ratios (ROE, ROA, ROS) Market share Competitive It measures the firm's capability Customer performance to meet the expectations and satisfaction needs of the client Satisfaction of employees It measures the consensus of Institutional employees turnover rate stakeholders - not the clients - on Relationship with banks performance the way the firm works 25 THE FIRM-ENVIRONMENT RELATIONSHIP Customers Stakeholders THE FIRM Input Activities Output Products Collaboration Primary resources Financial and Labor $ Management offers Other resources services Technical-industrial property Organization Competitive Institutional Commercial property Accounting 26 THE FIRM-ENVIRONMENT RELATIONSHIP Product Goods Services Physical products Nonphysical products 27 THE FIRM-ENVIRONMENT RELATIONSHIP Product - goods Product Features Service Features Quality Purchase services Design Usage services Branding Packaging 28 THE FIRM-ENVIRONMENT RELATIONSHIP Product - services Service Characteristic Implications Intangible Associate service with something tangible Perishable Manage demand to utilize supply Inseparable Capitalize advantages of person providing service Not homogeneous Standardize service delivery as much as possible 29 THE FIRM-ENVIRONMENT RELATIONSHIP Product Consumer Products Products that are Business Products purchased by consumers Products purchased by a for their own personal firm or organization for its use. own use. 30 THE FIRM-ENVIRONMENT RELATIONSHIP Client Market size Number of clients Volumes Socio-demo profile Segments consumer behavior purchasing process … Needs / expectations Segmentation Geographical market criteria Socio-demographic elements Purchasing habits 31 THE FIRM-ENVIRONMENT RELATIONSHIP Stakeholders CONTRIBUTIONS STAKEHOLDERS FIRM REWARDS 32  THE FIRM-ENVIRONMENT RELATIONSHIP Stakeholders A ‘Stakeholder’ is: Any person or organisation who can be positively or negatively impacted by, or cause an impact on the actions of a company. (Freeman, 1984) The individuals and constituencies that contribute, either voluntarily or involuntarily, to its wealth-creating capacity and activities, and are therefore its potential beneficiaries and / or risk bearers. (Post, Preston & Sachs, 2002) 33  THE FIRM-ENVIRONMENT RELATIONSHIP Stakeholders Owners, stockholders & investors Government & regulators: Banks and creditors local, national, international Partners & suppliers Professional and industry associations Buyers, customers & FIRM prospects Media: local, national, trade, financial Management NGOs Employees, unions, works councils Communities & other interest groups Competitors 34  FOCUS ON GOVERNANCE 35  ACTIVITIES - MANAGEMENT Managing a business: It means to direct activities. I direct production, I direct logistics, I direct marketing activities... This is managing, directing activities, processes. Governance: It consists of setting the rules under which managers can conduct their activities, that is, making clear the guidelines, the architecture of the bodies responsible for setting the rules. The CEO participates partially in governance, but is the big boss in terms of management. Who is really in charge of governing the company? The owners, the investors, because the company belongs to them. Management is not governance! 36  FOCUS ON GOVERNANCE A definition Corporate governance is the institutional framework that regulates the division and exercise of power in the corporation. [A.N. Licht, in Handbook of Key Global Financial Markets, Institutions, and Infrastructure, 2013] Corporate governance was defined in the Cadbury Report as ‘the system by which companies are directed and controlled’. The phrase corporate governance came into prominent use in the 1980s, and is often used narrowly to refer to the mechanisms and rules that govern relationships among direct corporate participants in publicly-traded firms, especially shareholders, directors, managers, and sometimes employees. [M.M. Blair, in International Encyclopedia of the Social & Behavioral Sciences, 2001] Corporate governance is something different from the daily operational management activities enacted by a company’s executives. It is a system of direction and control that dictates how a board of directors governs and oversees a company.  FOCUS ON GOVERNANCE Why is it needed? In most corporations, the owners (shareholders) do not manage the company’s operations. Corporate governance is needed to ensure that the managers are committed to return some of the firm’s profits to investors, invest properly the firm’s capital into effective projects. El gobierno corporativo es necesario para garantizar que los directivos se comprometen a de devolver parte de los beneficios de la empresa a los inversores, inviertan adecuadamente el capital de la empresa en proyectos eficaces.  FOCUS ON GOVERNANCE Corporate governance pillars Accountability Fairness Independence Transparency Ensure that Protect Shareholders Procedures and Ensure timely, management is rights structures are in accurate disclosure accountable to the place so as to on all material Treat all minimize, or avoid matters, including Board shareholders completely conflicts the financial including minorities, of interest situation, Ensure that the equitably performance, Board is Independent ownership and accountable to Provide effective Directors and corporate shareholders redress for violations Advisers i.e. free governance from the influence of others 39  FOCUS ON GOVERNANCE Separation of Ownership & Managerial Control Modern public corporation form leads to efficient specialization of tasks Risk bearing by shareholders. Strategy development and decision-making by managers It means that owners do not need to be managers and managers do not need to be owners. It is often the case that someone is both, like the case of Mark Zuckerberg at Facebook. In most small corporations, the owners typically manage the firm but it is not necessary that owners run the company or are even involved in the day-to-day operations of the company. Separation of ownership and management in corporate governance involves placing the management of the firm under the responsibility of professionals who are not its owners. Owners of a company may include shareholders, directors, government entities, other corporations and the initial founders. 40  FOCUS ON GOVERNANCE Separation of Ownership & Managerial Control Advantages: 1. The owners of a company may not have all of the necessary skills and experience needed for certain managerial roles. Creating a management team separate from the ownership enables the company to be run by professionals with diverse skills such as in marketing, corporate financing and public relations. 2. Performance appraisals are an essential part of good corporate governance, as they enable managers to evaluate the company and to point out areas of improvement. It can be complex to evaluate performance where there is a lack of separation of ownership and management. 3. Separate managers and owners in a firm ensure that a system of checks and balances is in place. Managers act as a buffer between the company and stakeholders such that they can alleviate negative impacts of stakeholder activities and avoid hitches in public relations. 41  FOCUS ON GOVERNANCE CG protagonists Owners Board of directors CEO Staff 42  FOCUS ON GOVERNANCE The board of directors A company's board of directors is the primary body influencing corporate governance A board of directors is essentially a panel of people who are elected to represent shareholders. Every public company is legally required to install a board of directors; nonprofit organizations and many private companies – while not required to – also name a board of directors. The directors are responsible for setting the company’s strategic aims, providing the leadership to put these into effect, supervising the management of the business and reporting to shareholders on their stewardship. [Glynis D Morris BA FCA,... Andrea Oates BSc, in Finance Director's Handbook (Fifth Edition), 2009]  FOCUS ON GOVERNANCE The board of directors: functions (1) Represent shareholders and create shareholder value. (2) Align the interests of management with those of shareholders while protecting the interests of other stakeholders (customers, creditors, suppliers). (3) Define the company’s mission and goals. (4) Establish or approve strategic plans and decisions to achieve these goals. (5) Appoint senior executives to manage the company in accordance with the established strategies, plans, policies, and procedures. (6) Oversee the company’s performance by setting objectives, establishing short-term and long- term strategies to achieve these objectives, and assessing the performance of senior executives in fulfilling their responsibilities without micromanaging. (7) Approve major business transactions and corporate plans, decisions, and actions. (8) Develop and approve executive compensation, pension, post-retirement benefits plan, and other long-term benefits, including stock ownership and stock options. 44  FOCUS ON GOVERNANCE The board of directors: functions (9) Review financial reports and other important financial disclosures such as management discussion and analysis (MD&A) earnings releases and reports disseminated to the public. (10) Review management’s report on the effectiveness of internal control over financial reporting. (11) Provide counsel to the company’s senior executives, especially the CEO, on material strategic decisions and risk management. (12) Ensure the company’s compliance with applicable laws, rules, and regulations. (13) Approve the company’s major operating, investing, and financial activities. (14) Set the tone at the top by promoting legal and ethical conduct throughout the company. (15) Evaluate the performance of the board, its committees (e.g., audit, compensation, and nominating), and the members of each committee. (16) Approve dividends, financing, capital changes, and other extraordinary corporate matters. (17) Oversee the sustainability of the company in creating long-term shareholder value and protecting interests of other stakeholders. 45  FOCUS ON GOVERNANCE The board of directors Most effective boards get their work done through committees that report to the full board. Setting up a small group of directors chosen for their relevant expertise has proven to be an effective way to examine complex issues. Audit, compensation, and nominating committees—in order of their recent rise to prominence—overshadow the older executive committee whose function tended to become that of the entire board. The board of directors It is the protagonist of governance along with other companies. It is in an intermediate position between shareholders, investors and Source: https://hbr.org/1979/09/the-boards-most-important-function managers. It makes decisions that impact the management of the company on behalf of the owners, the shareholders. -Within the board, the CEO is very important. The CEO is the person with the highest responsibility, the boss of the directors, the person with the highest responsibility for the management of the company. The board of directors has a small number of people who must make important decisions. All of them, all the members of the board of directors, represent the shareholders. El consejo de administración Es el protagonista de la gobernanza junto con otras empresas. Ocupa una posición intermedia entre los accionistas, los inversores y los directivos. Toma decisiones que afectan a la gestión de la empresa en nombre de los propietarios, los accionistas. -Dentro del consejo, el CEO es muy importante. El CEO es la persona con mayor responsabilidad, el jefe de los directores, la persona con mayor responsabilidad en la gestión de la empresa. En el consejo de administración hay un número reducido de personas que deben tomar decisiones importantes. Todos ellos, todos los miembros del consejo de administración, representan a los accionistas.  FOCUS ON GOVERNANCE CG relationship with stakeholders: Are stakeholders all the same? The ‘shareholder primacy’ view, which has been dominant in the US and other English-speaking countries since the 1980s, has focused on the set of governance problems that arise in publicly-traded corporations in which equity shares are held and traded by numerous individuals who have little or no management connection to the firm. In Europe and Asia (as well as in the US in the middle of the twentieth century), corporations are more likely to be viewed as institutions with a quasi-public character and role. Hence, the proper goal of corporate governance is more likely to be seen as a balancing of interests among all of the corporate stakeholders (so-called ‘stakeholder’ view of the firm).  FOCUS ON GOVERNANCE CG relationship with stakeholders: Are stakeholders all the same? Shareholder model versus the stakeholder model: Shareholder model - the purpose of the corporation is to promote shareholder value Stakeholder model - the purpose of the corporation is to serve a wider range of interests 48  FOCUS ON GOVERNANCE CG relationship with stakeholders: Are stakeholders all the same? UK/US approach European approach 49  FOCUS ON GOVERNANCE CG relationship with stakeholders: Are stakeholders all the same? The needs of all (salient) stakeholders must be recognized through the firms actions. A firm’s strategic competitiveness is enhanced when its governance mechanisms take into consideration the interests of all (salient) stakeholders. Only when the proper corporate governance is exercised can strategies be formulated & implemented that will help the firm achieve strategic competitiveness & earn above average returns. 51  FOCUS ON GOVERNANCE CG relationship with stakeholders: Are stakeholders all the same? - Employees Employee participation in CG: Examples Rights to consultation Duties of board members to consider stakeholder interests Rights to nominate/vote for supervisory board members Compensation/privatization programs making employees shareholders 52  FOCUS ON GOVERNANCE The board of directors: an example https://corporate.pirelli.com/corporate/en-ww/governance/board-of-directors-and-corporate-bodies/board-of-directors  FOCUS ON GOVERNANCE Un miembro ejecutivo del consejo de administración de una empresa (o de una organización sin ánimo de lucro) también tiene responsabilidades de gestión. Un miembro no ejecutivo o independiente del consejo no tiene responsabilidades en la gestión diaria ni en las operaciones de la empresa u organización. An executive member of the board of a firm (or a non- profit organisation) has also management responsibilities. A non-executive or independent board member is without responsibilities for daily management or operations of the company or organisation. https://corporate.pirelli.com/corporate/en-ww/governance/board-of-directors-and-corporate-bodies/board-of-directors  FOCUS ON GOVERNANCE https://corporate.pirelli.com/corporate/en-ww/governance/board-of-directors-and-corporate-bodies/board-of-directors Strategy and management Class 3 The financial performance of a company: the income statement WE ALREADY SAID…. Management activities Run the business Organization activities Organize the business Accounting activities Record the business 2  WE ALREADY SAID… TO SUM UP: Accounting is an organized way of measuring and summarizing the information - mainly quantitative and financial in nature - related to the activities of business. The users of accounting information rely on accounting information to make decisions. 3  WE ALREADY SAID… KPI Financial It measures the firm’s Profit performance capability to be profitable Financial ratios rentabilidad Competitive It measures the firm's capability Market share performance to meet the expectations and Customer satisfaction needs of the client expectaciones de los clientes It measures the consensus of Satisfaction of Institutional employees stakeholders - but not the clients - performance Relationship with banks on the way the firm works consenso de las partes interesadas 4  How to analyze the financial performance of a company? 5  THE ACCOUNTING SYSTEM The primary output of accounting activities is a set of financial statements and accompanying footnotes Balance de situación Cuenta de resultados Balance Sheet Data Regarding: Income Statement Revenues Ingresos Accounting Statement of Cash Flows Expenses Gastos Préstamos bancarios processes Statement of Bank loans Stockholders’ Equity Other events and transactions Footnotes 6  ORGANIZING A FIRM’S TRANSACTIONS Bookkeeping is the mechanical act of managing and recording external transactions Accounting is the application of accounting principles and conventions to the bookkeeping data to produce financial statements that fairly represent the financial condition and operations of the economic entity External Transactions Internal Transactions occur between the organization occur within the organization and an outside party 7  THE DOUBLE ENTRY SYSTEM An external business transaction involves an exchange between two accounts. The double entry accounting is a record keeping system under which every transaction is recorded in at least two accounts. In double entry accounting, the total of value of the entries has to be ZERO. When this happens, the transaction is said it be "in balance." If the totals do not agree, the transaction is said to be "out of balance". 8  ORGANIZING A FIRM’S TRANSACTIONS Each external transaction generates two opposite items A. Purchasing and selling transactions : Transacciones de compra y venta : Operation 1: selling a product Operation 2: purchasing a service on account Cash Debt. FIRM CUSTOMER SUPPLIER FIRM Revenue Cost B. Collecting or paying money from accounts: Operation 3: pay off accounts SUPPLIER Cash out FIRM Pay off debt 9  ACCOUNTING PRINCIPLES The most basic principles of accounting are: 1. The entity concept 2. The going concern principle 3. The period of analysis 4. The cost principle 5. The monetary value 6. The matching principle 7. The revenue recognition 10  ACCOUNTING PRINCIPLES 1. The entity concept Separate account must be maintained for each business entity 2. The going concern principle The statements are prepared on the basis that the economic entity will continue to operate in the future (hence liquidation values, for example, are not relevant) 11  ACCOUNTING PRINCIPLES 3. The period of analysis It is helpful to view business performance in time frames. Usually a fiscal year, although half a year, quarterly and monthly financial statements are also produced. Annual 1 2 Half year 1 2 3 4 Quarter 1 2 3 4 5 6 7 8 9 10 11 12 Month 12  ACCOUNTING PRINCIPLES 4. The cost principle Assets, liabilities, or equity investments have to be recorded at their original acquisition cost. 13  ACCOUNTING PRINCIPLES 5. The monetary value All business transactions can be expressed in terms of money Why money? common denominator in economic activities stable reliable relevant universally available 14  ACCOUNTING PRINCIPLES 6. The matching principle Los gastos deben reconocerse y registrarse cuando dichos gastos pueden corresponderse con los ingresos que contribuyeron a generar Expenses should be recognized and recorded when those expenses can be matched with the revenues they contributed to generate. Now that we have recognized the Summary revenue, let’s see what expenses we of Expenses Rent $1,000 incurred to generate that revenue. Gasoline 500 Advertising 2,000 Salaries 3,000 Utilities 450 and........ 15  ACCOUNTING PRINCIPLES 7. The revenue recognition (accrual principle) Expenses should be recognized and recorded when those expenses can be matched with the revenues they contributed to generate. Accrual Basis Cash Basis Revenues are recognized Revenues are recognized when earned and expenses when cash is received and are recognized when expenses recorded when incurred. cash is paid. Accounting 16  FINANCIAL STATEMENTS 1 Balance sheet 2 Income statement 3 Statement of cash flows 4 Statement of Stockholders’ Equity 17  THE INCOME STATEMENT Also known as the profit and loss statement An income statement reports on activities occurred during the financial period considered (like a movie) It lists sales (revenues), gains, costs and losses over a period of time It reports expenses incurred in order to earn that income (application of the matching principle) 18  THE INCOME STATEMENT NET INCOME = TOTAL REVENUES & GAINS - TOTAL EXPENSES & LOSSES Increase in retained earnings Decrease in retained from delivering goods or earnings from operations; services to customers the cost of doing business NET INCOME > 0 = PROFIT NET INCOME < 0 = LOSS 19  THE INCOME STATEMENT REVENUES & GAINS Income is increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants (IASB Framework). It includes revenues and gains. Los ingresos son incrementos de los beneficios económicos durante el periodo contable en forma de entradas o incrementos de activos o disminuciones de pasivos que dan lugar a aumentos del patrimonio neto, distintos de los relativos a las aportaciones de los participantes en el capital (Marco IASB). Incluye ingresos y ganancias. Revenue arises in the course of the ordinary activities of an entity and is referred to by a variety of different names including sales, fees, royalties, etc. The sales of tourism package is an ordinary activity that generates revenues for a travel agency. Gains represent other items that meet the definition of income but are not related to the ordinary activities of an organization. Inventory represents the amount of the costs of products awaiting to be sold on the market. The inventory of a product includes the cost of its raw materials, work-in-process, and finished goods that means all costs necessary to acquire the inputs and transform them into products ready for sale. 20  THE INCOME STATEMENT gastos y perdidas EXPENSES & LOSSES Expenses are the costs incurred to generate revenues, so they are related to the ordinary activity of a company or to its financial activities. Examples are: cost of raw materials, cost of personnel, cost of distribution, cost of services, administrative expenses, …) Losses are items that generate a decrease in the economic benefit of an entity but are not related to the ordinary activities, Losses can result from a number of activities such as; sale of an asset for less than its carrying amount, the write- down of assets, or a loss from lawsuits. 21  THE INCOME STATEMENT The income statement could have one of these 2 structures Multi-step Single-step Expenses Revenues Net income 22  THE INCOME STATEMENT Revenues deducción por costes u otros gastos de explotación asociados a la obtención de los ingresos. O adición de otros tipos de ingresos que la empresa obtuvo en el periodo. deduction for costs or other operating expenses associated with earning the revenue. Or addition of other kinds of Net income income the company earned in «bottom line» the period 24  THE INCOME STATEMENT XYZ Income statement 2022 This is an example of an income statement Costs of products as it appears in the sold to customers annual report: Vertical structure Costs resulting from Intermediate normal recurring margins business activities Split between operating and non operating activities Revenues and expenses incurred by company loans or investments 25 ANALYZING AN INCOME STATEMENT: IKEA 26 27  ANALYZING THE INCOME STATEMENT When looking at the income statement it is important to analyze not only the net profit, but also the intermediate margins realized in the different kinds of activities run by the firm Sales (or Revenues) Less: variable operating costs Operating Equals: contribution margin activities Less: fixed operating expenses Equals: EBIT (income from operations) Plus: other income and gains such as interest income Less: other expenses and losses such as interest expense Non Equals: profit before tax and extraordinary items operating Less: extraordinary items activities Equals: profit before tax Less: taxes Equals: net profit 28  ANALYZING THE INCOME STATEMENT Earning margins related to the different kinds of activities carried out by a firm: EBIT revenues(ingresos)- operating expenses (gastos de explotacion) Indicator of a company's operating profitability, calculated as revenues minus operating expenses, excluding tax and interest. (Even called "operating earnings", "operating profit" and "operating income”) Profit before tax and extraordinary items This measure combines all of the company's profits before tax, including operating and non-operating activities except extraordinary items and taxes Profit before tax A profitability measure that doesn’t include corporate income tax. This measure deducts all expenses from revenue but it leaves out the payment of tax. (Even called "earnings before tax”) 29  ANALYZING THE INCOME STATEMENT Why should we divide items according to firm’s activities and assess margins? To find an answer to some critical issues! Where does the net income come from? How much reliable is it? How much relevant is the operating activity? 30 ANALYZING THE INCOME STATEMENT Income statement 2014 Firm A Firm B Revenues 100 100 Op. expenses -90 -50 EBIT 10 50 Net financial interests 10 10 Profit before tax and 20 60 extraord. Items Extraordinary items 35 -5 PBT 55 55 Taxes -25 -25 Net income 30 30 31  ANALYZING THE INCOME STATEMENT – FOCUS ON THE OPERATING SECTION A focus on the operating section: between revenues and EBIT vary depending on firm’s production volumes. Variable costs increase if Variable costs production increases and decrease if production decreases. Examples are raw materials, inventory. are independent from firm’s production volumes. Fixed costs don’t change Fixed costs according to any increase or decrease of production. Examples are rentals, cost of personnel. Contribution Margin Sales (or Revenues) measures how much of Less: variable operating costs revenues contribute - after covering the Equals: contribution margin variable expenses - to cover the firm’s fixed Less: fixed operating expenses costs Equals: EBIT (income from operations) 32  ANALYZING THE INCOME STATEMENT – FOCUS ON THE OPERATING SECTION Why should we divide operating expenses into variable and fixed costs? To understand the cost structure (proportion of fixed and variable costs) Rigid cost structure Flexible cost structures (higher fixed costs) (higher variable costs) 33  ANALYZING THE INCOME STATEMENT – FOCUS ON THE OPERATING SECTION A focus on the operating section: between revenues and EBIT Total amount of the costs used to create a product or service which has been sold. mporte total de los costes utilizados para crear un producto o servicio que vendido. This amount includes the cost of the materials and labor directly used to create the good. It does not include any general and administrative expenses nor any Cost of sales costs of the sales and marketing department (indirect expenses). It is also commonly known as the “cost of goods sold (COGS)” = Beginning inventories + purchasing - ending inventories It is useful to determine its gross profit, a profitability measure that evaluates how efficient a company is in managing its labor and supplies in the production process REVENUES – COGS = GROSS PROFIT (OR GROSS MARGIN) 34  ANALYZING THE INCOME STATEMENT – FOCUS ON THE OPERATING SECTION A focus on the operating section: between revenues and EBIT gastos de explotacion (empresa y sus proveedores) Operating expenses that require a payment. These expenses result from Real costs external purchasing transactions between the company and its suppliers. Depreciación y amortización, gastos que no pueden asociarse a un pago (costes no monetarios) Depreciation and amortization, expenses that can’t be associated to a payment (non-cash costs) because they are not the result of an external Non-cash costs transaction, but they derive from the application of an accounting technique required to fulfill the matching principle. EBITDA Contribution margin Earnings Before Interests, Taxes, Depreciation and Less: fixed operating monetary expenses Amortization. It is used to Equals: EBITDA analyze and compare Less: depreciation & amortization (non monetary) profitability between companies Equals: EBIT (income from operations) and industries because it EBITDA eliminates the effects of Beneficios antes de intereses, impuestos, depreciaciones y amortizaciones. Se utiliza para analizar y comparar la rentabilidad entre empresas e industrias porque elimina los efectos de investing decisions. las decisiones de inversión. 35  ANALYZING THE INCOME STATEMENT – FOCUS ON THE OPERATING SECTION A focus on the operating section: between revenues and EBIT Sales (or Revenues) Less: variable operating costs Contribution margin Less: fixed operating monetary expenses EBITDAR = beneficios antes de intereses, impuestos, depreciaciones, amortizaciones y Equals: EBITDAR alquileres. Less: rentals Al excluir los gastos de alquiler, es más fácil comparar una empresa con otra y hacerse una idea Equals: EBITDA más clara de sus resultados operativos en el caso de empresas, Less: depreciation & amortization Equals: EBIT (income from operations) EBITDAR = earnings before interests, taxes, depreciation, amortization and rentals. By excluding rent expenses, it is easier to compare one company to another and get a clearer picture of their operational performance in case of firms, such as hotels or restaurants, that have significant rental and lease expenses derived from business operations. 36 ANALYZING THE INCOME STATEMENT – FOCUS ON THE OPERATING SECTION ingresos 37 ANALYZING THE INCOME STATEMENT – FOCUS ON THE OPERATING SECTION 38 ANALYZING THE INCOME STATEMENT – FOCUS ON THE OPERATING SECTION 39  ANALYZING THE INCOME STATEMENT A focus on the operating section 1. Total revenue Cost of goods sold(COGS = beginning inventory + purchasing – ending inventory) Variable costs Other variable costs 2. Variable costs 3. Contribution margin (1-2) Administrative expenses Labor cost Other operating expenses Fixed costs 4. Fixed period costs 5. EBITDAR (3-4) 6. Rental expenses 7. EBITDA (5-6) 8. Amortization and depreciation 9. EBIT (7-8) Interest revenue Financial expenses 10. Total net financial expenses 11. Profit before tax and extraordinary items (9-10) 12. +/- Extraordinary items 13. Profit before tax (11-12) 14. Income tax expenses 15. Net Profit (13-14) 40  ANALYZING THE INCOME STATEMENT Firm A Firm B Firm C 1. Revenues 1000 1000 1000 - Variable costs -200 -100 -400 2. Contribution margin 800 900 600 - Operative expenses -250 -320 -600 3. EBITDA 550 580 0 - Amortization and depreciation -100 -30 -30 4. EBIT 450 550 -30 + Interest revenue 0 50 230 - Financial expenses -100 -300 -50 6. Profit before tax and extraordinary items 350 300 150 +/- Extraordinary items -50 0 +150 7. Income taxes 300 300 300 - Taxes -150 -150 -150 8. Net Profit 150 150 150 41 Strategy and management Class 4 The financial position of a company: the balance sheet  THE BALANCE SHEET The balance sheet is a financial ‘snapshot’ at one point in time (usually on the last day of the firm’s fiscal year) It is an ‘inventory’ of what the firm owns (assets) and how those assets are financed (liabilities and owners equity) – Left-hand side lists assets – Right-hand side lists liabilities and owners equity inventario» de lo que posee la empresa (activos) y cómo se financian activos (activo) y cómo se financian (pasivo y fondos propios). - En el lado izquierdo figuran los activos - A la derecha, el pasivo y los fondos propios 2  THE BALANCE SHEET Assets are the company’s economic resources ASSETS (money, goods and properties, credits, …) ACTIVO: Los activos son los recursos económicos de la empresa (dinero, bienes e inmuebles, créditos,...) Liabilities are obligations to third parties arising LIABILITIES from past events (bank loans, debt to suppliers, …) PASIVO: El pasivo son las obligaciones con terceros derivadas de hechos pasados (préstamos bancarios, deuda con proveedores,... Shareholders’ equity is the overall amount of SHAREHOLDERS’ shareholders’ investments into the firm. It is what the EQUITY firm owes to its owners FONDOS PROPIOS: Los fondos propios son el importe total de las inversiones de los accionistas en la empresa. Es lo que la empresa debe a sus propietarios. 3  THE BALANCE SHEET A balance sheet reports on investing and financing activities. It lists amounts for assets, liabilities, and equity at a point in time. The relationship is reflected in the Balance Sheet equation: ASSETS = LIABILITIES + EQUITY Liabilities Economic Obligations to third Obligations to resources parties shareholders Assets “outsider claims” “insider claims” Equity ASSETS = LIABILITIES + PAID-IN CAPITAL + RETAINED EARNINGS Earnings from income-producing Amounted invested in the activities kept for use in the corporation by business. This is affected by stockholders Revenues and Expenses Although throughout the fiscal year the numerous operations vary the property of the firm, the equation is always respected. 4  THE BALANCE SHEET The balance sheet December 31, 2016 Assets Liabilities Cash 300 € Trade accounts payable 400 € Trade accounts receivable 400 € Long-term loans 300 € Inventories 50 € Net deferred taxes 150 € Equipment 400 € Design patent 50 € Plants 100 € Shareholders’ equity Shareholders’ capital 250 € Net income for the year 200 € TOTAL ASSETS 1,300 € TOTAL LIABILITIES 1,300 € AND EQUITY 5  THE BALANCE SHEET It provides information on the financial health of an organization. When analyzed over several periods, it could assist in identifying trends in the financial position of the organization. It is helpful in determining the organization's liquidity risk, financial risk, credit risk and business risk. When combined with other financial statements of the organization and the financial statements of its competitors, it may help point out strengths and weaknesses of the organization. 6  ANALYZING THE BALANCE SHEET The balance sheet analysis allows the reader to evaluate investing and financing activities of the firm in terms of: 1) evaluation of the assets’ composition to assess the risks the firm bears 2) evaluation of the financial sources’ section (liabilities and shareholders’ equity) to understand the financial risks the firm bears (in terms of weight of liabilities compared to shareholders’ equity) 3) comparison between the nature of investments and financial resources 7  ANALYZING THE BALANCE SHEET The balance sheet analysis consists on repositioning the items of the two sections according to different logics to get new information (reformulated balance sheet). It allows to assess the solvency of the firm both in the short and long term. In the financial balance sheet left-side and right-side items are positioned according to two different logics: ➔ ASSETS Assets are listed according to the “liquidity logic”, from the most liquid (cash) to the less one (fixed assets) ➔ LIABILITIES Liabilities are positioned according to the temporal term of the obligations, from the short term to the long term 8  ANALYZING THE BALANCE SHEET Financial balance sheet Dec. 31 XXXX Assets Liabilities Cash, and cash equivalents Net trade accounts receivables 1. Short term (or current) liabilities Other credits Debts to suppliers, other debts State Bonds 1. Quick assets 2. Long term (or non current) liabilities 2. Inventory Severance fund, bank loans, Ending inventories - beginning inventories borrowings over 12 months 3. CURRENT ASSETS (1+2) 3. TOTAL LIABILITIES (1+2) 4. Tangible net fixed assets Equipment, land, Shareholders’ equity (- Depr. fund) 5. Intangible net fixed assets 4. SHAREHOLDERS’ EQUITY Goodwill, patents (- Amort. fund) Subscribed (or shareholders’) capital 6. Financial fixed assets Reserves Stocks (or interests), shares in affiliates.. Profit or loss for the financial year 7. FIXED ASSETS (4+5+6) 8. TOTAL NET ASSETS (3+7) 5. TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY (3+4) 9  ANALYZING THE BALANCE SHEET Let’s compare balance sheets Firm A Firm B Firm C Current Current Assets Current Liab. 15% Current 20% Liab. 25% Assets Current Current Long term 40% Liab. 65% Assets Long term Liab. 15% Liab. 50% 80% Fixed Fixed Assets S. Equity Assets Long term 80% S. Equity 60% 60% Liab. 25% Fixed 35% Assets 20% S. Equity 10% 10 ANALYZING A BALANCE SHEET: IKEA 11 12 Strategy and management Class 5 The financial ratios  FINANCIAL RATIOS For an in-depth firm’s performance evaluation two methods are available: 1. Financial analysis Reformulated statements What are they? 2. Financial ratios Why should be used? How many ratios do exist? 2  FINANCIAL RATIOS What are they? static key performance indicators mathematical comparisons of financial statements’ items or categories. don't take into consideration the size of a company or the industry so they can also be used to compare different companies in different industries. to judge whether a ratio is ‘good’ or ‘bad’ it is necessary to compare it with something else, such as: the company’s own ratios over time to ascertain trends other comparable companies or industry averages 3 FINANCIAL RATIOS Why should be used? Easy to be assessed and evaluated Significant changes in key financial ratios from one period to the next may provide important insight into the future prospects of a firm. These insights allow investors, lenders, and other decision-makers to make informed and rational economic decisions regarding the firm 4  FINANCIAL RATIOS How many ratios do exist? There are 4 main groups of financial indicators Liquidity Solvency Profitability Growth ratios ratios ratios ratios Ability of the Ability of the Ability of the Ability of the firm to meet its firm to generate firm to provide firm to grow short-term future revenues financial over time obligations and meet long- rewards through current term obligations sufficient to resources attract and retain financing 5 LIQUIDITY RATIOS saber si puedo cumplir mis obligaciones a corto plazo 6  CURRENT RATIO Current ratio measures the number of euros of current assets for each euro of mide el número de euros de activo corriente por cada euro de pasivo corriente. current liabilities. Ayuda a estimar la capacidad de pago de deudas a corto plazo de la empresa. It helps estimate the short-term debt-paying ability of the company. CA Current Ratio = CL Current Assets = Current Liabilities around 1 1 = reference or higher value