Bocconi Business Planning and Control PDF

Business Planning and Control (cod. 30694) CLEACC Session 2 From Financial to Managerial Accounting Accounting Based Performance Measures and the Need for Managerial Accounting Accounting based performance measurement...

Business Planning and Control (cod. 30694) CLEACC Session 2 From Financial to Managerial Accounting Accounting Based Performance Measures and the Need for Managerial Accounting Accounting based performance measurement The company’s ability to offer products/services at a higher value than the value of the resources used. PROFITABILITY The company’s ability to overcome particularly negative The company’s ability to cope LONG-TERM internal or external events. It with all monetary outflows LIQUIDITY SOLVENCY is logically linked to cash resulting from its operations. generation and leverage indicators GROWTH The company’s ability to grow in terms of volumes (revenues) while maintaining over time a balanced performance in terms of profitability, long-term solvency and liquidity 2 Profitability ❑ Operating profitability Return on Investment (return on Assets) is an indicator of operating profitability EBIT that holds great managerial relevance. It relates the operating income to the ROA/ROI = invested capital (total assets), i.e. the investments required to obtain it. It 𝑇𝐴 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 𝐸𝐵𝐼𝑇 expresses management's ability to leverage tangible and intangible assets for profit = ∗ 𝑇𝐴 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 generation. It is the result of two indicators: the turnover of invested capital and the profitability of sales. The first determinant of ROI, the turnover of capital employed expresses management's ability to leverage capital employed (TA) to generate business 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 opportunities and thus revenues. It is based on the optimization of working capital 𝐴𝑠𝑠𝑒𝑡 𝑡𝑢𝑟𝑛𝑜𝑣𝑒𝑟 = 𝑇𝐴 and the saturation of fixed investments, and therefore it correlates with managerial levers related to operational activities and medium to long-term decisions. The optimization of this parameter is usually associated with high volume strategies. Return on sale is the second determinant of ROI. It expresses management's ability to generate profitable business opportunities. It is an important objective for 𝐸𝐵𝐼𝑇 𝑅𝑂𝑆 = managerial accounting mechanisms, as it correlates with managerial levers such as 𝑅𝑒𝑣𝑒𝑛𝑢𝑒𝑠 the ability to generate value for which customers are willing to pay an appropriate price, and the ability to optimize resource utilization within those limits. AT = Capital ROS = Sales profitability and operating efficiency productivity 3 Profitability ❑ Net profitability A concise indicator, Return on equity measures the return on investments made by shareholders. Net income, in fact, remains after satisfying all other stakeholders and is 𝑁𝑃 attributable to risk capital holders. As a summary indicator, it is influenced by factors beyond 𝑅𝑂𝐸 = operational ones, such as the financial structure. If the numerator is replaced with PBT (profit 𝐸 before taxes), it is referred to as gross ROE and is useful for comparisons that disregard different tax regulations. Relevant for managers: ✓ Shareholders requests in term of ROE, determine conseguences on targets in term of ROA 4 Solvency It represents the overall level of indebtedness, easily derived from the balance 𝐷 𝐷𝑒𝑏𝑡 to 𝑒𝑞𝑢𝑖𝑡𝑦 𝑟𝑎𝑡𝑖𝑜 = sheet. D (debt) includes all liabilities, whether current or long-term, financial 𝐸 or operational. Financial leverage measures the financial structure of the company, i.e. the 𝑁𝐹𝑃 proportion through which it finances net invested capital. Unlike the D/E 𝐺𝑒𝑎𝑟𝑖𝑛𝑔 𝑟𝑎𝑡𝑖𝑜 = ratio, it directly expresses the choices made for covering net needs generated 𝐸 by the business through financing or equity leverage. Net financial position measures the financial indebtedness of the company (financial liabilities-FL), net of liquid assets readily available for debt repayment (Cash & Cash Equivalents). It is an absolute value, and therefore 𝑁𝐹𝑃 = 𝐹𝐿 − 𝐶&𝐶𝐸 more consistently should find a place in Table 1.1. It is included here because it is often indicated as a solidity objective in communication processes and business plans. 5 The importance of dimensions’ correlation 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡𝑠 𝐷 𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝑅𝑂𝐸 = [𝑅𝑂A + (𝑅𝑂𝐴 − 𝐷 ) ∗ 𝐸 ] ∗ 𝑃 𝐵𝑒𝑓𝑜𝑟𝑒 𝑇𝑎𝑥𝑒𝑠 Operating profitability Tax charge Financial lever: the difference between return and cost of debt act as a lever on Net profitability Attention: ❑ Additional debt requires opportunities with higher returns ❑ Debt, in turn, determines impact on profitability (necessary to remunerate higher interests) and requires higher liquidity to serve debt payments ❑ Debt is easy to increase but it’s very difficult to reduce it if necessary Application – A detailed example in the reference book: Fundanalysis Case, verify profitability and solvency performance ratios described in the previous slides 6 Application: Netflix case (calculations) 7 Application: Netflix case (calculations) – solve on excel (*) let's assume that Long term debt are financial debts. All other liabilities are operating. It is just for computation purposes 8 Università Bocconi - Programmazione e Controllo (cod.30694) - Anno Accademico 2016-2017 Application: Netflix case (calculations) – solve on excel 9 Università Bocconi - Programmazione e Controllo (cod.30694) - Anno Accademico 2016-2017 The impact of dimensional growth Long term strategy NFP/E = 1.5 = growth 20% NFP = 600 NIC = +20% NIC = 1,000 Equity = if 400 NFP/E = 1.5 NFP = 720 (+20%) NIC = 1,200 Equity = 480 (+20%) g(S) g(NIC) g(E) 10 The impact of growth This model assumes that: ❑Among the different performance dimensions, solvency is the consequence of profitability, liquidity and growth performances ❑Growth is a MUST for any company. ❑Each company should define a level of solvency consistent with its profitability and liquidity performances. ❑In the short run, the company can increase its debts to finance its growth strategies, but in the long run it must generate returns from investments and use them to reduce its debts to desired consistent level Investments D/E Investments for growth (NFP/E) for growth Desired level Consistent with: - Profitability - Liquidity 11 Balanced management of performance perspectives Solvency Invested Retaned Growth Strategy Capital earnings Shareholders management strategy Target setting ROS Performance Ex post Managerial awareness ROI management Asset strategy accounting Turnover 12 Netflix case 13 Università Bocconi - Programmazione e Controllo (cod.30694) - Anno Accademico 2016-2017 Netflix case Sales 35,000,000 30,000,000 25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 - 16,000,000 14,000,000 12,000,000 10,000,000 8,000,000 FCF 6,000,000 LT debt 4,000,000 2,000,000 - -2,000,000 -4,000,000 14 Università Bocconi - Programmazione e Controllo (cod.30694) - Anno Accademico 2016-2017 Management accounting vs financial accounting Financial Accounting Management Accounting Output Users External Internal Focus Whole company Small parts (products, departments, customers, etc.) Compliance to legal Constraints Effectivness of information produced in supporting requirements and GAAP decision-making, planning and control Frequency Annually or semi-annually Montly, weekly, daily Time dimension Past Past and future 15 The Need For Management Accounting and features of MA mechanisms Frequent Analytical Measurement Methodology Multidimensionality Understand Measure Learning performance segmented drivers performances Multidisciplinarity Forward looking Adapt Flexibility performance Set targets measures to Integration business needs Motivation Specificity Guide and align Support managerial managerial Feedback Accountability decisions evaluation Relevance Interaction 16 Università Bocconi - Programmazione e Controllo (cod.30694) - Anno Accademico 2016-2017