Making Financial Decisions Mid Term Exam 2021 PDF

**Making Financial Decisions** Mid Term Exam Lena Ivic 2021 Contents {#contents.TOCHeading} ======== [LU 1: Recap of CBV and Operating Results Analysis 4](#lu-1-recap-of-cbv-and-operating-results-analysis) [**Balance Sheet** 4](#balance-sheet) [**The Income Statement** 5](#the-income-statement) [**Cost of Sales Formula** 5](#cost-of-sales-formula) [**Balance Sheet Analysis** 6](#balance-sheet-analysis) [**Horizontal Analysis** 6](#horizontal-analysis) [**Vertical Analysis** 6](#vertical-analysis) [**Base Year Comparison** 6](#base-year-comparison) [**Ratio Analysis** 7](#ratio-analysis) [**Financial Leverage** 11](#financial-leverage) [**Operating leverage** 11](#operating-leverage) [LU 2: Predicting Profitability and Controlling Costs 12](#lu-2-predicting-profitability-and-controlling-costs) [**Fixed Cost** 12](#fixed-cost) [**Variable Cost** 12](#variable-cost) [**Step Cost** 12](#step-cost) [**Mixed Cost** 12](#mixed-cost) [**High-Low Method to determine Mixed Cost Elements** 12](#high-low-method-to-determine-mixed-cost-elements) [**Management choosing multiple Payment Options** 13](#management-choosing-multiple-payment-options) [**Direct vs. Indirect Costs** 13](#direct-vs.-indirect-costs) [**Other Cost Definitions you should know** 13](#other-cost-definitions-you-should-know) [**Indifference point** 14](#indifference-point) [**Cost Volume Profit Analysis** 15](#cost-volume-profit-analysis) [**Assumptions made by CVP** 15](#assumptions-made-by-cvp) [**Basics of CVP** 15](#basics-of-cvp) [**CRM~W~** 15](#crmw) [LU 3: Managing Working Capital 17](#lu-3-managing-working-capital) [**Working Capital** 17](#working-capital) [**Operating Cycle** 19](#_Toc90294520) [**Managing your inventory** 20](#managing-your-inventory) [**Managing Accounts Payable** 20](#managing-accounts-payable) [**Managing Short Term Loans** 20](#managing-short-term-loans) [**Float** 21](#float) [**Lockbox System** 21](#lockbox-system) [**Integrated Cash Management** 21](#integrated-cash-management) [LU4: Managing Cash Flow 22](#lu4-managing-cash-flow) [The Ultimate Guide to Making Your Cash Flow Statement 23](#the-ultimate-guide-to-making-your-cash-flow-statement) [**Net Cash Flow from Operating Activities** 23](#net-cash-flow-from-operating-activities) [**Net Cash Flow from Investing Activities** 23](#net-cash-flow-from-investing-activities) [**Net. Cash Flow from Financing Activities** 24](#net.-cash-flow-from-financing-activities) [**Making a Cash Budget** 26](#making-a-cash-budget) [**How does a Cash Budget Look Like and What Should I Include?** 27](#how-does-a-cash-budget-look-like-and-what-should-i-include) [**Other formulas** 28](#other-formulas) [**Dupont analysis** 29](#dupont-analysis) [January] -- 31 days [[February]](https://www.timeanddate.com/calendar/months/february.html) -- 28 days in a [[common year]](https://www.timeanddate.com/date/common-year.html) and 29 days in [[leap years]](https://www.timeanddate.com/date/leapyear.html) (**2000, 2004, 2008, 2012, 2016, 2020)** [[March]](https://www.timeanddate.com/calendar/months/march.html) -- 31 days [[April]](https://www.timeanddate.com/calendar/months/april.html) -- 30 days [[May]](https://www.timeanddate.com/calendar/months/may.html) -- 31 days [[June]](https://www.timeanddate.com/calendar/months/june.html) -- 30 days [[July]](https://www.timeanddate.com/calendar/months/july.html) -- 31 days [[August]](https://www.timeanddate.com/calendar/months/august.html) -- 31 days [[September]](https://www.timeanddate.com/calendar/months/september.html) -- 30 days [[October]](https://www.timeanddate.com/calendar/months/october.html) -- 31 days [[November]](https://www.timeanddate.com/calendar/months/november.html) -- 30 days [[December]](https://www.timeanddate.com/calendar/months/december.html) -- 31 days **Solving 2 variable Equation** X=Y+6 X+Y=50 (Y+6) + Y = 50 2 Y = 44 Y = 22 X+ 22= 50 X = 28 ***Variance*** Absolute = new -- old OR Relative = (new -- old) / old \* 100 **LU 1: Recap of CBV and Operating Results Analysis** ===================================================== USALI = Uniform System of Accounts for the Lodging Industry **Balance Sheet** ----------------- = Financial statement reflecting the financial position of the operation, at a [given point in time]. Shows a firm's assets, and claims to it's assets (liabilities and owner's equity). Useful for conveying financial information to creditors and investors. \- The Account Format lists the asset accounts on the left side of the page and the liability and owner's equity accounts on the right side. \- The Report Format shows assets first, followed by liabilities and owner's equity. +-----------------------------------+-----------------------------------+ | **Assets = Liabilities + Equity** | | +===================================+===================================+ | **Current Assets** (within the | **Current Liabilities** (within | | next 12 months) | the next 12 months) | | | | | \- cash | \- short term debt | | | | | \- accounts receivable | \- accounts payable | | | | | \- marketable securities | \- advance deposits | | (short-term investments) | | | | \- income tax payable | | \- inventory | | | | \- accrued expenses | | \- prepaid expenses | | | | \- dividends payable | | \- operating equipment (linen, | | | china, silverware) | \- current maturities of | | | long-term debt | | ➔ Liquidity = measures the | | | operation's ability to convert | **Noncurrent Liabilities** | | assets to cash | (beyond the next 12 months) | | | | | **Noncurrent assets** (beyond the | \- long term debt | | next 12 months) | | | | \- bonds payable | | \- property | | | | \- mortgage payable | | \- equipment | | | | \- notes payable | | \- land | | | | **Owner's equity** | | \- trademarks | | | | \- common stock issued | | \- goodwill | | | | \- additional paid-in capital | | \- investments | | | | \- retained earnings | | | | | | \- treasury stock | +-----------------------------------+-----------------------------------+ **The Income Statement** ------------------------ = Report the success of a company's operations over a period of time - Shows revenues and expenses, with a subsequent profit/loss - The profit/loss is then transferred to the owners equity (owner pays for what is lost/won) **Basic Format of Income Statement** Revenue Operated Departments \- Cost of Sales = Gross Profit \- Operating Expenses = Income before fixed charges \- Fixed Charges = Income before taxes \- Corporate Income Taxes = NET INCOME **EBITDA** = Earnings before interest, taxes, depreciation and amortization, shows the effectiveness & efficiency of an operation (ITDA are fixed and out of control of operation) **Net. Book Value** = Acquisition Cost -- Accumulated Depreciation **Gain/loss on sale of assets** = Selling price -- Net book value **Cost of Sales Formula** ------------------------- Beginning Food Inventory \+ Food inventory purchases = Food available for sale \- Ending Food Inventory = Cost of Food Sales \- Staff Meals = Cost of Food Sold **\ ** **Balance Sheet Analysis** -------------------------- **Horizontal Analysis** ----------------------- = comparative statement, comparing two or more time periods of the balance sheet/income statement, both absolute change and relative change is shown **Balance Sheet** 2019 2020 Absolute Relative\* ------------------- ----------- ----------- ---------- ------------ Assets 1 000 000 1 500 000 500 000 50% Liabilities 750 000 250 000 500 000 66.67% Owners Equity 250 000 300 000 50 000 20% \*Relative = (new -- old) / old = absolute change / old Amount in new year -- Amount in old year for absolute change **Vertical Analysis** --------------------- = AKA common-size analysis, changing financial information to percentages [Important:] Income statement: as % of total revenue, Balance Sheet: as % of total assets The small accounts making up total assets and total L&E are expressed as a percentage of that 100%. This analysis is not used to calculate the overall growth of the company, but [rather to identify changes in its structure] or to compare differently sized companies (e.g. company buys building, so it has a bigger property account and a smaller cash account when compared to last year) Formula: Value of small account/Value of Total Assets (or total L&E) make sure the two values are from the same year, there is no between years calculation for vertical analysis **Balance Sheet** 2020 Common Size ---------------------- ------------- ------------- Current Assets 150 000 000 60% Property & Equipment 75 000 000 30%... TOTAL ASSETS 250 000 000 100% **Base Year Comparison** ------------------------ = base year is 100%, subsequent years are always compared to the chosen base year Here, all first year accounts are considered 100%. We then calculate next years' accounts: Formula: Amount in new year/Amount in old year\ for change in management or strategy; (give absolute numbers and) relative numbers 2015 (BY) 2016 2017 2016/2015 2017/2015 --------------- ----------- ------ ------ ----------- ----------- **Cash** 100 110 150 110% 150% **Inventory** 2000 2100 2200 105% 110% **Equipment** 1500 1650 1800 110% 120% **Ratio Analysis** ------------------ - Ratios must be compared to another standard in order to become useful (ratio from past period, industry averages, budgeted ratio) - Expressed in percentage, per unit, turnover of x times, coverage of x times (denominator is 1) **What are ratios used for?** \- Ratios help **managers** monitor the operating performances of their operations and evaluate their success in meeting a variety of goals \- **Creditors** use ratio analysis to evaluate the solvency of hospitality operations and to assess the riskiness of future loans. \- **Investors** and potential investors use ratios to evaluate the performance of a hospitality operation. **Increasing current ratio or net working capital** \- Obtaining long-term loans \- Issuing new stock \- Converting noncurrent assets to cash \- Deferring declaring dividends and leaving the cash in the business **The 5 Ratios you should know** ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- **Liquidity Ratios:** Shows the ability of firm to meet it's short term obligations (what assets do I have with which I can pay my bills soon or right now?) **Solvency Ratios:** Shows by how much the firm is financed by debt (liabilities), and can show if the firm can meet its long-term obligations, as well as how big the cushion is that the owner's equity can provide if things don't go well **Activity Ratios:** Shows management's effectiveness in using its resources, especially it's fixed assets (such as the fixed amount of rooms available) **Profitability Ratios:** The results of all areas of management's responsibilities, mostly generating profit with the resources available **Operating Ratios:** Assists Management in analyzing the operations of a hospitality establishment, allows for comparison in time or competitors, can be useful for control purposes +-----------------------+-----------------------+-----------------------+ | Ratio | Formula | Notes | +=======================+=======================+=======================+ | Current Ratio | Current Assets / | Owners prefer low | | | | (they want investment | | | Current Liabilities | in non-current | | | | assets), creditors | | | | prefer high (timely | | | | payments), management | | | | is in the middle | +-----------------------+-----------------------+-----------------------+ | Acid-test ratio | Quick Assets / | Quick Assets = Assets | | | | minus inventories (so | | | Current Liabilities | Cash, AR, Marketable | | | | Securities), same | | | | preferences as in | | | | current ratio | +-----------------------+-----------------------+-----------------------+ | Operating Cash Flows | Operating Cash Flows | All users prefer | | to Current | (Net. Cash from | high, it shows firm | | Liabilities Ratio | operations) / | can pay their current | | | | liabilities. | | | Average current | | | | liabilities | Average current | | | | liabilities = | | | | (liabilities | | | | beginning of year + | | | | liabilities end of | | | | year) / 2 | +-----------------------+-----------------------+-----------------------+ | Accounts Receivable | Total Revenue / | Measures the speed of | | Turnover | Average Accounts | conversion of | | | Receivable | accounts receivable | | | | into cash, owners | | | | prefer high, | | | | suppliers prefer | | | | high, creditors | | | | prefer high | +-----------------------+-----------------------+-----------------------+ | Average Collection | 365 / Accounts | The lower the better, | | Period | Receivable Turnover | shows how long it | | | | takes to collect | | | | Account Receivables | +-----------------------+-----------------------+-----------------------+ | Working Capital | Total Revenue / | Owners prefer high, | | Turnover | | creditors prefer low, | | | Average Working | management is in | | | Capital | between | +-----------------------+-----------------------+-----------------------+ | Average working | (Beginning Working | | | capital | capital + ending | | | | working capital) / 2 | | +-----------------------+-----------------------+-----------------------+ | Net working capital | Current assets -- | Shows ability to pay | | | current liabilities | current debt with | | | | current assets | +-----------------------+-----------------------+-----------------------+ | Return on Equity | Net income / Equity | \- | +-----------------------+-----------------------+-----------------------+ | Financial Leverage | \- | ![](media/image2.png) | | | | Using | | | | debt (liabilities) | | | | instead of equity to | | | | finance operations | | | | and increase the | | | | return on equity by | | | | investing liabilities | | | | rather than equity | +-----------------------+-----------------------+-----------------------+ | Solvency Ratio | Total Assets / | The greater financial | | | | leverage, the lower | | | Total Liabilities | the solvency ratio, | | | | owner's prefer high | | | | leverage (thus more | | | | liabilities), | | | | creditors prefer high | | | | solvency ratio | +-----------------------+-----------------------+-----------------------+ | Debt-equity ratio | Total Liabilites / | Shows the firm's | | | | ability to meet its | | | Total Owner's Equity | long-term obligations | | | | & withstand | | | | adversity, owners | | | | want high ratio, | | | | creditors low, | | | | management is in | | | | middle | +-----------------------+-----------------------+-----------------------+ | Long-term debt to | Long-term debt / | As a percentage | | total capitalization | long-term debt and | | | ratio | owner's equity | | +-----------------------+-----------------------+-----------------------+ | Number of times | Earning before income | The number of times | | Interest Earned Ratio | tax / Interest | the interest expense | | | Expense | can be covered, a | | | | high number can | | | | satisfy creditors | +-----------------------+-----------------------+-----------------------+ | Fixed charge coverage | EBIT / Interest | | | ratio | Expense and lease | | | | expense | | +-----------------------+-----------------------+-----------------------+ | Debt service coverage | (Net operating income | | | ratio | -- cash transfers to | | | | replacements | | | | reserves) / debt | | | | service payment | | +-----------------------+-----------------------+-----------------------+ | Operating Cash Flow | Operating Cash Flow / | | | to Total Liabilities | | | | Ratio | Average Total | | | | Liabilities | | +-----------------------+-----------------------+-----------------------+ | Food Inventory | Cost of Food used / | Average -\> | | Turnover | Average Food | (Inventory beginning | | | Inventory | of year + Inventory | | | | end of year) / 2 | | | | | | | | High turnover means | | | | less cost of | | | | inventory (storing, | | | | security, insurance), | | | | but too high can lead | | | | to sell out | +-----------------------+-----------------------+-----------------------+ | Property/Equip-ment | Total Revenue / | High turnover | | Turnover | | suggests the firm is | | | Average property and | using its property | | | equipment | efficiently to | | | | generate revenue | +-----------------------+-----------------------+-----------------------+ | Asset Turnover | Total Revenues / | Examines the use of | | | | total assets in | | | Average Total Assets | relation to total | | | | revenue | +-----------------------+-----------------------+-----------------------+ | Paid Occupancy | Paid rooms occupied / | Allows to compare | | | | market penetration of | | | Available Rooms | a hotel | +-----------------------+-----------------------+-----------------------+ | Complimentary | Complimentary Rooms / | | | Occupancy | | | | | Available Rooms | | +-----------------------+-----------------------+-----------------------+ | Average Occupancy per | Number of guests / | | | Room | Number of occupied | | | | rooms | | +-----------------------+-----------------------+-----------------------+ | Average length of | Total occupied rooms | | | stay | / \# of bookings | | +-----------------------+-----------------------+-----------------------+ | Multiple Occupancy | Rooms occupied by \> | | | | 2 people / Rooms | | | | occupied | | +-----------------------+-----------------------+-----------------------+ | Seat Turnover | Customers served / | | | | | | | | (number of seats X | | | | number of days open) | | +-----------------------+-----------------------+-----------------------+ | Profit Margin | Net Income / | Overall measurement | | | | of firm's ability to | | | Total Revenue X 100 | general sales and | | | | control expenses, | | | | bottom line | +-----------------------+-----------------------+-----------------------+ | Operating Efficiency | Gross Operating | ![](media/image4.png) | | Ratio (GOP margin | Profit / | GOP | | ratio) | | only includes | | | Total Revenue X 100 | expenses that are in | | | | control of of the | | | | department | | | | management. Excludes | | | | management fees, | | | | fixed charges etc. | +-----------------------+-----------------------+-----------------------+ | Net. Margin % | Net. Income / Net. | | | | Revenue X 100 | | +-----------------------+-----------------------+-----------------------+ | GOPPAR | Gross Operating | Measures the | | | Profit / Number of | management's ability | | | available rooms | to create profit over | | | | costs they can | | | | control | +-----------------------+-----------------------+-----------------------+ | Return on Assets | Net Income / | Indicator of | | | | profitability of | | | Average Total Assets | firm's assets | +-----------------------+-----------------------+-----------------------+ | Gross return on | EBIT / average total | | | assets | assets | | +-----------------------+-----------------------+-----------------------+ | GROA | EBIT / Average total | | | | assets | | +-----------------------+-----------------------+-----------------------+ | Return on Owner's | ROA X (Av. Total | Shows how much profit | | Equity | Assets / av. Total | the company can make | | | Owner's Equity) | with the investments | | | | of the owner | | | **OR** Net Income / | | | | | | | | Av. Total Owner's | | | | Equity | | +-----------------------+-----------------------+-----------------------+ | Return on common | Net income -- | | | stock holders equity | preferred dividends | | | | /average common | | | | stockholders equity | | +-----------------------+-----------------------+-----------------------+ | Earnings per share | Net Income / Av. | | | | Common Shares | | | | Outstanding | | +-----------------------+-----------------------+-----------------------+ | Price/Earnings Ratio | Market Price per | | | (PE) | share / Earnings per | | | | share | | +-----------------------+-----------------------+-----------------------+ | Sales Mix | Sales Product X / | | | | | | | | Sales all Products | | +-----------------------+-----------------------+-----------------------+ | ADR | Room Revenue / | | | | | | | | Number of rooms sold | | +-----------------------+-----------------------+-----------------------+ | RevPAR | Room Revenue / | | | | | | | | Available Rooms | | | | | | | | **OR** Paid Occ. % X | | | | ADR | | +-----------------------+-----------------------+-----------------------+ | RevPAC | [Total] | Shows total revenue | | | Revenue / | achieved from average | | | | hotel guest | | | Total number of | | | | guests | | +-----------------------+-----------------------+-----------------------+ | Average Food Check | Total Food Revenue / | | | | | | | | Number of food | | | | customers | | +-----------------------+-----------------------+-----------------------+ | Labor Cost Percentage | Total Labor Cost / | | | | | | | | Total Revenue | | +-----------------------+-----------------------+-----------------------+ Average cost = Total costs/Units produced Incremental cost = Variable costs/Units produced **Sleeper nights calculation** Sleeper nights: Think of it as counting the number of guests in the building every night and adding up the results. So if 7 people stay in a hotel room one night, and the room is free for the rest of the week, it yields 7 sleeper nights. If only one person rents out a room for 7 nights, it also yields 7 sleeper nights. Sleeper nights = Total number of guests \* average length of stay OR Total rooms sold \* average number of guests in a room **Financial Leverage** ---------------------- **=** The degree to which a business is utilizing debt Low -\> mostly financed through equity (conservative) p.17 High -\> mostly financed though liability (risky) p.17 The leveage increased and materially changed the risk pattern of the company. The risk is higher expressed through leverage Pros: Can increase owner's return on investment (he likes it if the revenue is made with debt, not his/her own money they put in),+ debt financing has tax advantages Cons: risk of bankruptcy if income falls short in case the EBIT is not high enough and interest cannot be paid to creditors Financial leverage = av. Total assets/ av. total liability Solvency ratios useable , if solvency goes down financial leverage goes up **Calculate ROE difference as well as KPI !! reflect on financing policy (risk/conservative)** **Operating leverage** ---------------------- = The degree to which the costs of a business are fixed rather than variable; The more fixed costs, the more leveraged the company is. **High operating leverage** High fixed costs -- low variable costs**\ **- high CMR**\ **- gyms, RD department Implications of High Leverage: - Meaning high fixed costs, relatively low variable cost, high risk and high pay off - If your revenues exceed your break-even point, you will make a lot of profit (fixed costs are already "paid off", the variable costs are low) - It is more difficult to reach your break-even point, if you sales are under BEP, then you lose a lot of money **Low operating leverage** Low fixed costs -- high variable costs**\ **- low CMR**\ **- F&B, supermarkets Implication of Low Leverage - Meaning low fixed costs, relatively high variable cost, low risk and low pay off - If your revenue exceed your Break-even point, you don't make a lot of money as your variable costs are still pretty high - It is easier to reach your break-even point, so it is more difficult to lose much money Degrere of Operating Leverage (DOL) = Contribution Margin % or CMR~W~ / EBT % over Sales OR DOL = change in net income/change in sales EBT % over Sales = Earnings before Taxes / Total Revenue ![](media/image6.png)Change in EBT % = DOL X Change in Sales % **LU 2: Predicting Profitability and Controlling Costs** ======================================================== **Cost/Expense:** The reduction of an asset, generally for the purpose of increasing revenue !!! Not all costs are perfectly fixed or variable, but sometimes we assume they are!!! **Fixed Cost** -------------- - Remain constant in the short run, even when sales volume varies - E.g. salaries, rent expenses, property taxes, depreciation expense - Fixed cost per unit declines as sales volume increases - **Avoidable Costs:** Fixed costs that can be avoided when a company shuts down - **Capacity Fixed Cost:** Costs that are crucial to provide goods/services (e.g. rent of building to provide hotel rooms) - **Discretionary Fixed Cost:** Are not crucial to provide goods/services in the short run, but will lead to problems in the long run (training, advertising, seminars) - These are usually cut to achieve a budget or in a financial crisis - **Variable Cost** ----------------- - Increase proportionally with volumes of sales, variable cost per unit remains approximately the same **Step Cost** ------------- - Constant within a range of activity, but different among different ranges of activities - Step cost can be "fixed cost", if the range of activity of the cost is larger than the range of activity of the company **Mixed Cost** -------------- - Costs that consist of part fixed and part variable (fixed cost always remains, variable depends on level of activity) - Total Mixed Cost = Fixed Cost + (Variable Cost per unit X unit sales) Total Cost = Fixed Cost + (Variable Cost per unit X units sold) Y = a + bx TC = FC + VC/U \* U **High-Low Method to determine Mixed Cost Elements** ---------------------------------------------------- 1. Take the period with highest sales volume and lowest sales volume 2. Calculate the difference in Sales Activity (e.g. units sold, rooms sold, etc) 3. Calculate the difference between the (Total) costs of those two periods 4. Divide the difference in Cost by the difference in Sales Activity, this gives you the **Variable Cost per Unit** 5. Multiply the Variable Cost per Unit by either one of the Sales Activities, which gives you the **Total Variable Cost of that period** 6. Subtract the **Total Variable Cost** from the (Total) Cost of that same Sale Activity (whichever one you chose in Step 5), this gives you the **Total Fixed Cost** 7. Using the fixed cost, you can find the variable cost for any month you like [Worked Example ] Maintenance Cost Ice Creams Sold ---------------- ------------------ ----------------- August (Low) 3500 500 January (High) 4500 700 **Difference** 1000 200 Variable Cost per Unit = 1000/200 = 5 Euros per unit Total Variable Cost = 5\*500 = 2500 Euros Total Fixed Cost = 3500 -- 2500 = 1000 Euros [Others methods to split Mixed Costs: Scatter Diagram & Regression Analysis] **Management choosing multiple Payment Options** ------------------------------------------------ - Oftentimes, goods/services can be purchased through a variable, fixed or mixed cost arrangement, so you need to calculate all of them to see the cheapest one (this depends on the level of activity that you calculate with!) - **Indifference Point**: Level of activity where it does not matter which arrangement is chosen, as at this point they all cost the same **Direct vs. Indirect Costs** ----------------------------- - Direct costs are directly liked to revenue-generating departments (e.g. F&B) - Indirect (overhead) expenses cannot be linked to one revenue-generating department (e.g. management fees, property taxes, deprecation etc.) - Overhead expenses include all costs other than the direct costs - This includes undistributed operating expenses (adm. & general, Inf. & Telec., Sales & Marketing, Maintenance etc.), Management fees and non-operating expenses (insurance, rent, depreciation, property taxes etc.) - Management or the BoD can decide to distribute the overhead expenses over all the profit centers (AKA cost allocation) - Single allocation base approach (SABA): Using one criteria to distribute overhead expenses over profit centers (e.g. square meters of department, Sales mix, number of employees etc.) - Multiple allocation base approach (MABA): Same as SABA but with multiple criteria's **Other Cost Definitions you should know** ------------------------------------------ - **Controllable Cost**: Costs over which a person is able to exert an influence and hence should be able to keep within predefined boundaries or limits. (e.g. cost of food sold, payroll expense, how much food is used for a dish (menu planning), or how fast supplies are used (dispenser systems for cleaning supplies), NOT rent expense) - **Differential Cost**: The difference in cost between two options (of cost arrangements), buying a new computer or keeping an old one that is slower and thus makes operations less quick - **Relevant Cost**: Costs that must be considered in a decision-making situation, they have to be future, differential and quantifiable (means that the cost has to occur after the decision is made, must be different from each other and must be put into an actual number), A guests wants to check-in last minute in a hotel, there is one room available but it has not yet been cleaned. The reception personnel is already on duty and their payroll is already accounted for, but the housekeeper might just be ready to call it a day. A relevant cost at this point would be the overtime of the housekeeper. - **Opportunity** costs are the costs of foregoing benefits of the best alternative option in a decision-making situation involving several options, the cost of the second best option - **Sunk Cost**: Past cost relating to past decisions, irrelevant for decision making because they already occurred. (for example, advertising expenditures. If you advertise a new menu item, money you used to advertise previous menu items is gone and cannot be retrieved. - **Average Cost**: the total production and service costs divided by the quantity of production Formula: total costs/total sales - **Incremental Cost:** The cost to produce one more unit, includes the variable cost and variable part of mixed cost ; when producing 9 units for a variable costs of X per unit, the incremental costs for producing the 10th unit will be X Formula: variable costs/total sales - **Standard Cost:** A forecast of what actual costs should be under fixed conditions (e.g. standard cost of a recipe or meal) When making a budget at the beginning of the fiscal year, all costs budgeted can be considered standard costs. **Indifference point** ---------------------- This only comes up when choosing between two options for costs (usually 2 suppliers), where one makes you a fixed offer (e.g. 1 million for the whole year) and the other offers you a variable cost option (e.g. 1 \$ per guest served). The indifference point is the volume at which the two options are the same. Since the fixed option is constant, the question you should ask is: how much should the company sell so that the variable option costs, in the end, just as much as the fixed option? For example: Supplier 1 asks for a flat fee of 1 million \$ per year Supplier 2 asks for a fee of 2 \$ per guest The indifference point is where the variable supplier (2) charges you as much as the flat fee, so 1 million per year. Since their fee is 1 \$ per guest, we calculate 1 million / 2 \$ = 500,000 guests Note: The indifference point is all about volume, so for example you can have the indifference point at 100 rooms sold, at 1 million euros revenue, at 100 guests served etc. **Cost Volume Profit Analysis** ------------------------------- = set of analytical tools to check what the revenue required is to make a desired profit, either in graphic or equation form **Assumptions made by CVP** --------------------------- - Fixed Costs remain fixed - Variable Costs increase in a linear line (fixed VC/unit) - Revenue is directly proportional to volume (linear) - Mixed costs can be divided into variable and fixed parts - CVP looks only at numbers, not how employees feel, how guests behave etc. **Basics of CVP** ----------------- **Breakeven point (BEP):** The level of sales volume at which total revenue equals total cost **Contribution Margin (CM):** Selling price minus variable cost, the money that is left to pay the fixed cost and to make a profit (hopefully) CM (contribution margin) = Revenue -- variable costs **Contribution Margin Ratio (CMR)**: CM / Selling Price **OR** 1 -- VC%, shows how much of the sales is contribution margin CMR (contribution margin ratio) = (Revenue -- variable costs)/revenue OR 1 -- VC% **CRM~W~** ---------- **Method 1:** Use the share of revenue to determine CMR (can be different products, departments etc.) CMR (Product 1) x Share of Revenue (Product 1) + CMR (P2) x Share of Revenue (P2) +... Share of Revenue of Product X = Revenue of Product X / Total Revenue CMRw = (CMR department1 \* Revenue department1 + CMR department2 \* Revenue department2 + so on and so forth with all departments)/Total revenue **Method 2:** CMR~W~ = (Total Revenue -- Total Variable Cost) / Total Revenue **revenue required at desired net. Income level:** Desired Revenue = (Total Fixed Cost + Income before taxes\*) / CMR~W~ \*If you want to find out revenue required at a certain [profit] level, just swap the Income before taxes with the Net. Income Income before taxes = Net Income / (1 -- tax rate) **Revenue required for a desired profit at a certain tax rate** R = (Ib + F)/CMRw Ib = Income before taxes = Net Income / (1 -- tax rate) F= fixed costs **Break-even point** = the level of sales a company must make so that total costs equal revenue and there is no profit/loss. Revenue at break-even = F/CMRw **Safety Margin**: A buffer to cover your costs, money you budgeted too much "just in case" Safety Margin = Margin of Safety = Revenue -- Break Even Point (in \$) Safety Margin Ratio = Safety Margin / Total Revenue +-----------------------------------+-----------------------------------+ | CVP Analysis (AKA breakeven) | | +===================================+===================================+ | Single Product CVP Equation | BEP = Profits is zero = (Selling | | | Price X Units sold) -- (Variable | | | Cost per Unit X Units Sold) -- | | | Total Fixed Costs | +-----------------------------------+-----------------------------------+ | Multiple Product CVP Equation | Revenue = (Fixed Cost + Net | | | Income) / CMR~W~ | +-----------------------------------+-----------------------------------+ | Multiple Product CVP Equation | Revenue = (Fixed Cost + Income | | with Income Tax | before income taxes) / CMR~W~ | +-----------------------------------+-----------------------------------+ | Revenue at Breakeven | Revenue = Fixed Cost / CMR~W~ | +-----------------------------------+-----------------------------------+ | Revenue at Desired Profit Level | Revenue = (Fixed Cost + Desired | | | Profit) / CMR~W~ | +-----------------------------------+-----------------------------------+ | Contribution Margin Ratio | Contribution Margin / Selling | | | Price | +-----------------------------------+-----------------------------------+ | Contribution Margin | CM = Selling Price -- Variable | | | Costs per Unit | +-----------------------------------+-----------------------------------+ | Contribution Margin Weighted | CMR~W~: (Total Revenue / Total | | | Variable Cost) / Total Revenue | | | | | | Need another method? Check in | | | Chapter above! | +-----------------------------------+-----------------------------------+ **LU 3: Managing Working Capital** ================================== **Cash Management**: The management of a firm's [cash balances] (currency and demand deposits), [cash flow] (cash receipts and disbursements) and [short-term investments] in securities This is important for all companies, because insufficient cash can lead to bankruptcy! You need sufficient cash to cover short-term debts and cover operational expenses that need to be paid in cash (suppliers etc.) Your minimal cash balances should: cover risk of cash shortfalls, provide adequate petty cash, provide adequate house banks, cover cheques issued **The difference between Income and Cash Flows** Income flows comes from revenue and expenses shown on the income statement Cash flows comes from cash receipts and disbursements !!!You can generate a profit and have a negative cash flow (revenue is not the same as cash in, expense is not the same as cash out!!! **Types of Cash** **Transaction Motive:** The reason for maintaining adequate balances (minimum balances) in checking accounts to cover checks that are drawn Good to know: Banks also influence the minimum balance for checking accounts, to serve as compensating balances for bank loans **Working Capital** ------------------- **Working Capital =** Current Assets -- Current Liabilities Why keep track of your Working Capital? - Measures your financial health - Positive working capital shows that you can pay your short-term debts - You should be able to have enough cash available to pay cash expenses **Current Ratio =** Current Assets / Current Liabilites If you have a lot of cash, it is easier for you to pay your short-term debts, but this does not mean that your working capital is automatically higher **Ways of funding net working capital - financing policy\ \ **Short term debt is cheaper than LTD because more things can happen in the long term 1\. short term debt to fund part of the fluctuating current asses (conservative, because if circumstances get bad refinancing risk is high, therefore small short term debt is less risky) 2\. short term debt to fund all of the fluctuating current asses 3\. short term debt to fund all of the fluctuating current asses and part of the permanent assets (aggressive/ risky ) Additionally lower accounts receivable with discounts **Ways of increasing net working capital\ **1. Long term debt for current assets 2\. selling stock (EQ) for current assets (not pressure to pay back , but high return to investors) 3\. accounts payable instead of short term loan ( no interest) **increase in current assets such as inventory is an operational risk if demand decreases** **[Determine the effective interest rate of the working capital loan if a 10% compensating balance is required.]** Multiply the loan principal by the stated interest rate to calculate the nominal interest due on the loan. A \$100,000 loan with a 5 percent interest rate would have nominal interest of \$5,000. Record the compensatory balance required from your loan. The bank will record the necessary compensatory balance on your loan application. Subtract the compensatory balance from the total principal to calculate the available balance. If your total loan is for \$100,000 and the compensatory balance is \$5,000, your available balance is \$95,000. Divide the nominal interest due by the available principal to calculate the effective interest rate of your compensatory balance installment loan. Note: Account1 refers to beginning of the year in the balance sheet and account2 refers to the end of the year (for example, if you are doing long term debt for the years 20x4 and 20x5, long term debt in 20x4 is written LTD1, long term debt in 20x5 is written LTD2) **Operating Cycle** ------------------- **Cash Conversion** Cycle = The time until the investment in inventory (as inventory is a very short term investment to make more money at the end) is returned back in cash (returned as in goods sold and collected). You wanna have as little inventory as possible and as little money in accounts receivable (because it just sits there) +-----------------------------------+-----------------------------------+ | Operating and Cash Flow Cycle | | +===================================+===================================+ | Inventory Holding Period (IHP) | IHP = (Average Food Inventory/ | | | Daily COS)\*365 | +-----------------------------------+-----------------------------------+ | Accounts Collection Period (ACP) | ACP = (Average Accounts | | | Receivable / | | | | | | (Credit Sales or Revenue)\* 365 | +-----------------------------------+-----------------------------------+ | Payables Deferral Period (PDP) | PDP = (Average Accounts Payable / | | | Daily COS )\*365 | +-----------------------------------+-----------------------------------+ | Cash Conversion Cycle (CCC) | CCC = IHP + ACP -- PDP | +-----------------------------------+-----------------------------------+ | Operating Cycle (OC) | OC = ACP + IHP | +-----------------------------------+-----------------------------------+ \*! If food and beverage together still divide by 2 , not 4 !! You want IHP to be short, ACP short as well and PDP as long as possible! **What is good and bad about sales on credit** Pro's: Increase in CM from increased sales (basically making more revenue) Con's: Increase in cost of investment in accounts receivable (you have to put effort in to actually get the money, possibly increase in debt expense) Improvements of the CCC = Have long term agreements and negotiate stable payment terms with suppliers Try to negotiate longer payment terms for PDP suppliers Provide a new additional financing for months with positive CCC Explain improvements through cash discounts or better payment terms **Managing Accounts Receivable (AKA Credit Payments)** - Credit selection: To whom will credit be extended - Credit terms: for how long the credit is given - Credit monitoring: Continuously reviewing account balances - You should always review the guest's account throughout their stay, and monitor the credit accounts after checkout so that they get paid - Normally, credit payments are collected with letters, phone calls, collection agencies, or worst case with legal action **Managing your inventory** --------------------------- Your inventory is just right when... - It is relatively low (inventory is low for hotels, especially rooms division) - You can optimally support your operations with the inventory It is definitely too much when... - It ties up cash (the opportunity cost, you could have done something better with that money) - The storage costs are high - You have to throw things out because of the shelf life (wastage) **Managing Accounts Payable** ----------------------------- **Effective Annual Interest Rate of Foregoing a Cash Discount** **(AKA should I pay the Account Payable as soon as possible or not?)** Sometimes, a suppliers will give a small discount if you pay fast (e.g. 10 days is the discount period), since that is in his/her benefit. **How to write the terms** **1/10, n/30** This reads as: 1% discount if paid within the first 10 days (discount period), no discount (net.) if paid within 30 days (credit period) Effective Interest Rate = (Cash discount / **(**Invoice Amount -- Cash Discount**)**) X (Days in Year / Difference between end of discount period and final due date) [EXAMPLE]: If the effective interest rate (of cash discount) is 20%, then I would pay the bill early to get the discount (as long as I can pay the amount with the cash I have or [if] I have to take a loan, the interest rate is below 20%. If the interest rate of the new loan is higher, I might as well wait to pay.) \- compared to interest rate loan = pay later \+ compared to interest rate loan = pay early , get discount and loan Example from workbook: Determine the effective interest rate of the working capital loan if a 10% compensating balance is required. Compensating balance is 10% of the loan. **Managing Short Term Loans** ----------------------------- **Effective Cost:** The bank requires you to keep a minimum in the bank accounts (compensating balance), the minimum does not earn interest, which means the effective cost of a loan might be higher Short-Term Bank Loans ------------------------------------------ --------------------------------------------------------------------------------------------------------------------- Effective Interest Rate Amount of Annual Interest on Loan / (Loan -- Compensating Balance Amount) Effective Interest Rate at Cash Discount (Cash Discount / (Invoice Amount -- Cash Discount)) X (Days in Year / Difference End Discount Date and Finale Date) Interest Borrowed money (in Euros) x Interest rate x time **Line of Credit:** An informal, non-binding agreement that tells you how much money you can borrow from the bank (although the bank can lower this at any point, though only on loans that are not signed for yet), interest is only charged on what is borrowed **Revolving Credit Agreement:** Similar to line of credit, but bank [guarantees] the amount of money that can be borrowed, in exchange for a commitment fee by the borrower on the [unborrowed] money (usually around 0.25%), if you borrow in the middle of the month, take the average unborrowed money **Float** --------- - The time between the subtraction/addition of cash to the company's books and the actual subtraction/addition to the bank account - Payment/disbursement float: time from which you subtract a payment in your books unit its gone from your account - Collection float: same concept but for addition to your books/bank - Net float: payment float -- collection float **Lockbox System** ------------------ A service provided by banks, where the checks from customers are sent straight to the bank (into a lockbox), where a staffer from the bank picks up the bill and deposits it straight into the company's accounts (as opposed to the bill going to the company, then the company having to go to the bank to deposit the cash, etc.) *Can speed up the collection of accounts receivable, but can also be costly* Breakeven amount = Bank charge per item / (**Daily** interest rate X change in time) Only when the average check amount is higher than the breakeven check should a lockbox system be considered ;) **Integrated Cash Management** ------------------------------ - For multi-property operations, an integrated cash management system is used that centralizes cash receipts and disbursements from a corporate office - Minimizes the amount of cash a single property holds - Increases return on cash because: 1) more cash in one place increases bargaining power with banks, 2) one centralized operation can employ more financial experts than multiple small operations **LU4: Managing Cash Flow** =========================== - *The statement of cash flow* shows the effects on cash that the operating, investing and financing activities of a firm have on the accounting period - It shows if the firm has a positive or negative cash flow, and thus shows if it can meet its (short-term) obligations such as paying suppliers, paying off short term loans etc. - Management uses the SCF to determine a firm's flexibility, and determines if it pays out dividends to its owners - The statement of cash flow shows you the location of the cash, the direction of the cash (in or out flows), and uses information from the income statement [and] the balance sheet **[Operating Activities]** (from income statement, relates to revenue/expenses) **[Investing Activities]** (from assets, relates to non-current assets/investments) ![](media/image9.png) **[Financing Activities]** (from debt & equity, relates to debt & capital stock) **The Ultimate Guide to Making Your Cash Flow Statement** ========================================================= *With the indirect method* **Net Cash Flow from Operating Activities** ------------------------------------------- 1. Start from net income 2. Check what your depreciation/amortization expense is (income statement), [add] whatever that expense is 3. if you gained anything from the sale of land/property/equipment/ investment a. If you gained money, subtract it b. If you lost money, add it 4. Now have a look at your current assets and current liabilities c. The following accounts you have to **ignore:** i. Cash (this will come at the very end) ii. Dividends payable (part of financial activities) iii. Marketable Securities (part of investing activities) iv. Current Part of long-term loans d. **asset** (acc receivables, inventory, prepaid expenses) any increase in that account (from beginning to end of year) will be subtracted, any decrease will be added e. **liability (**acc payable, accrued expenses, income tax payable, accrued payroll, advanced deposits) , then any increase will be added, any decrease will be subtracted 5. Put it all neatly in one column **Net Cash Flow from Investing Activities** ------------------------------------------- 1. This looks at all your non-current assets and what happens to them 2. There are three main accounts that you have to look at: Marketable securities, purchase/sale of land/property/other investments, purchase/sale of equipment Start from 0 Step 1: Add if there is a DECREASE in marketable securities, investments, subtract if there is an INCREASE in marketable securities, investments Step 2: Non-current assets: Subtract if there is an INCREASE in building, land, equipment, add if there is an DECREASE in land only (if there is a decrease in building/equipment, refer to the steps below to figure out selling price of item) Step 3: Add if there is a gain on sale of investment, subtract if there is a loss on sale of investment, 3. Watch out!!! Marketable Securities are also investments which you can buy or sell! Check if you bought or sold some marketable securities! Calculating selling of building and equipment for investing cash flow: Step 1: Equipment1 + bought item - equipment2=initial purchase value of sold item (how much it was bought for) Step 2: Depreciation expense 2 + accumulated depreciation 1 -- accumulated depreciation 2= accumulated depreciation for the item that was sold Step 3: the result of step 1 -- the result of step 2 Purchase value of item-accumulated depreciation for item=book value of item Step 4: Book value+ gain on sale of equipment (or -- loss on sale of equipment)= final selling price Step 5: Add final selling price to investing cash flow **Net. Cash Flow from Financing Activities** -------------------------------------------- Cash repaid is just negative number from 1.c) 1. We probably paid some money towards our long-term loan, so we should account for that (AKA **current maturities of LTD**) a. See how much of the long-term debt has been paid this year under "Current portion of LT debt" at the **beginning of the year** i. This is a decrease in cash flow; therefore, we subtract short term debt beginning of the year, add short term debt end of the year b. Subtract the "Current portion of LT debt" at the **end of the year** from the total LT debt at the **beginning of the year** c. Check to see if there are any extra loans taken using the formula below\ Extra loan taken=Long term debt 2 - LTD1 - current portion of LTD2 2. The difference that you got from 2c) is basically the new loan that you took, which increases your cash flow (add), if the difference is zero then nothing happened! 3. You might have paid out some dividends over the year, which would decrease your cash flow! Only if dividends payable is given ! d. Find the dividend declared -\> Dividends declared = Retained earnings (beg. Of year) + Net. Income -- Retained Earnings (end of year) e. Find the dividends paid out -\> Dividends payable (beginning of year) + Dividends declared -- Dividends payable (end of year) f. Only the dividends paid out will affect your cash flow (subtract if positive) 4. You **do not** have to do anything with the Retained Earnings here! 5. Equity stuff: Add if there is an increase in common stock/additional paid in capital/capital sotock, subtract treasury stock/common stock repurchased (in the income statement) Now put everything neatly in order and make the finishing calculations at the end! At the end, the increase in cash should be the same as the increase in the account "cash", if not then there is probably a mistake and you should go back and see where it is! Operating cash flow+ investing cash flow+ financing cash flow [Example]: *Cash Flow from Operating Activities* --------------------------------------- ----------- -------------- Net. Income \$\$\$\$ Adjustments Depreciation expense \$\$\$\$ Gain on Sales of Investments -\$\$\$\$ **TOTAL** **\$\$\$\$** *Cash Flow from Investing Activities* Purchase of building -\$\$\$\$ Sale of Equipment \$\$\$\$ **TOTAL** **\$\$\$\$** *Cash Flow from Financing Activities* Payment of long-term debt -\$\$\$\$ Borrowed LTD \$\$\$\$ **TOTAL** **\$\$\$\$** Net Increase/Decrease in Cash \$\$\$\$ Cash at the Beginning \$\$\$\$ Cash at the End \$\$\$\$ ![Graphical user interface, application, table Description automatically generated](media/image10.jpeg) **Making a Cash Budget** ------------------------ You want to make sure you have enough cash at hand next year, so you make an estimate of cash disbursements for that period **How to improve Cash Availability** - - Accelerate cash receipts - Sell marketable securities - Spend less on inventory - Delay payment of suppliers - Borrow on short-term basis - Postpone dividend payments - Sell capital stock **How to invest if you have too much cash (yay!):** 1. [Risk]: How probable is it that I lose my investment? 2. [Return]: How is the rate of return (how much can I make with my investment?) 3. [Liquidity]: Can I convert the investment to cash quickly? 4. [Cost]: How much do I have to pay my broker (brokerage cost) 5. [Size]: How big are the funds that are available to invest? 6. [Time]: For how long can I invest my money? Do I need it in 5 years, 10 years etc. **How does a Cash Budget Look Like and What Should I Include?** --------------------------------------------------------------- **CASH BUDGET** **Month 1** **Month 2** **Month 3** **Notes** -------------------------------------- ------------- ------------- ------------- ---------------------------------------------------------------------- Estimated Cash Beginning \$\$\$\$ \$\$\$\$ \$\$\$\$ Take this from the last row of the previous month Estimated Cash Receipts: Everything that increases your cash that month Cash Sales \$\$\$\$ \$\$\$\$ \$\$\$\$ Credit Card Sales from this month \$\$\$\$ \$\$\$\$ \$\$\$\$ Check below for formula Credit Card Sales from last month \$\$\$\$ \$\$\$\$ \$\$\$\$ Check below for formula Other Revenue that increases Cash: \$\$\$\$ \$\$\$\$ \$\$\$\$ (interest revenue, sale of equipment etc.) TOTAL (of Cash Receipts) \$\$\$\$ \$\$\$\$ \$\$\$\$ Estimated Available Cash \$\$\$\$ \$\$\$\$ \$\$\$\$ Add the two arrows Estimated Cash Disbursements Cost of Sales \$\$\$\$ \$\$\$\$ \$\$\$\$ Cost of Labor \$\$\$\$ \$\$\$\$ \$\$\$\$ Other expenses \$\$\$\$ \$\$\$\$ \$\$\$\$ Pay back of loan \$\$\$\$ \$\$\$\$ \$\$\$\$ Depending on when you have to pay recent loans TOTAL (of Cash Disbursements) \$\$\$\$ \$\$\$\$ \$\$\$\$ Preliminary Estimated Cash -- Ending \$\$\$\$ \$\$\$\$ \$\$\$\$ Working Capital Loan \$\$\$\$ \$\$\$\$ \$\$\$\$ Can be on incremental basis (only in steps of for example 1000 Euro) Interest Repayment \$\$\$\$ \$\$\$\$ \$\$\$\$ The interest of the loan you take **FINAL ESTIMATED CASH** \$\$\$\$ \$\$\$\$ \$\$\$\$ Preliminary Estimated Cash + Working -- Interest Repayment (Orange arrow) means simply moving the value without any calculation (Green arrow) means you add it to the cell that it goes in (Red arrow) means you subtract it to the cell that it goes in **Other formulas** ------------------ +-----------------------------------+-----------------------------------+ | Other Formulas | | +===================================+===================================+ | Accounting Rate of Return (ARR) | Average Annual Net Income / | | | Average Investment | +-----------------------------------+-----------------------------------+ | Profitability Index | Present Value of All Future Cash | | | Flows / Initial Investment | +-----------------------------------+-----------------------------------+ | Present Value of all Future Cash | Future Value / (1+r)^n^ | | Flows | | | | r = Rate of Return, n = number of | | | periods (e.g. years) | | | | | | Is about the idea that money in | | | present is more valuable than | | | money in the future because you | | | can invest it | +-----------------------------------+-----------------------------------+ | Future Value | Present Value X (1 + r)^n^ | +-----------------------------------+-----------------------------------+ | Cash Flow | Net Income + Depreciation | +-----------------------------------+-----------------------------------+ | Payback Period | Project Cost / Annual CF | +-----------------------------------+-----------------------------------+ | Net Present Value (PV) | Present Value of all future Cash | | | Flow -- Initial Investment | +-----------------------------------+-----------------------------------+ | Average Investment | (Project Cost + Salvage Value) / | | | 2 | | | | | | Salvage Value = what you can sell | | | an asset for after complete | | | depreciation | +-----------------------------------+-----------------------------------+ | Average Annual Project Income | Revenue -- Expenses -- | | | Depreciation | +-----------------------------------+-----------------------------------+ | Breakeven Lockbox System | Charge per Item / (Daily Interest | | | Rate X Change in Time) | +-----------------------------------+-----------------------------------+ | Annual Additional Interest Earned | Amount Deposited X Daily Interest | | | Rate X Additional Time in Bank | +-----------------------------------+-----------------------------------+ | Processing Fee | Number of Deposits X Charge per | | | Deposit | +-----------------------------------+-----------------------------------+ **Dupont analysis** ------------------- ![](media/image11.png)

Making Financial Decisions Mid Term Exam 2021 PDF

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