LGB524 Project and Financial Management Image by Les_Stockton Aims and Objectives In this lecture you will: • Understand the two methods of Depreciation - Straight line method and the Reducing Balance method. • Analyse the methods of depreciation and consider how they fit into the financial statements. • Interpret and Analyse financial statements: • The Balance Sheet • The Income Statement • The Cash Flow Statement • Critically evaluate how the Statements are used together to provide financial information for business decision making. • Explain ratio analysis and application to business uses. 1
Depreciation Straight Line Method Cost of Bowing Machine £78,124 Estimated Residual Value at the end of its useful life £2,000 Estimated Useful Life 4 Years 78,124 – 2,000 = 76,124 76,124 / 4 = £19,031 £19,031 is the charge that appears in the income statement for each of the 4 years the asset appears in the accounts. Simplest and most commonly used depreciation method. It is calculated by taking the purchase or acquisition price of an asset subtract the residual value (what you could sell it for), divided by the total productive years the asset can be reasonably expected to benefit the company. Depreciation Reducing Balance Method Applies a fixed % rate of depreciation to the carrying amount of an asset each year. Cost of Bowling Machine £78,124 Yr 1 Depreciation charge (60% of cost) (48,874) Carrying amount 31,250 Yr 2 Depreciation charge (60% of carrying amount) (18750) Carrying amount 12,500 Yr 3 Depreciation charge (60% of CA) (7,500) Carrying amount 5,000 Yr 4 Depreciation (60% of CA) (3,000) RESIDUAL VALUE 2,000 This method assumes the asset loses more value in the early years of its life. Depreciation is recorded on both the balance sheet and the profit and loss accounts. 2
Depreciation Analysis If the Profit of the company who held the Bowling machine had a profit of £40,000 for each of the 4 years in which the asset was held the profit would be: Straight-Line Method – Each year: 40,000 (profit before depreciation) – 19,031 (Depreciation) = 20,969 Reducing-balance Method – Year 1 40,000 46,874 (6,874) Year 2 40,000 18,750 21,250 Year 3 40,000 7,500 32,500 Year 4 40,000 3,000 37,000 R-B method realises the cost in the majority of the first year. • Take 5 minutes to analyse this information. What conclusions can you make? Depreciation Evaluations SL method – constant profit figure. RB Method changing profit figure over time. Same amount of depreciation over the 4 year period. Only allocation between years differs. Calculating depreciation is a simple task, although some estimations have to be made. How do we realistically value goodwill of a business or a professional footballer? The figures sometimes cannot be 100% accurate and this has to be accepted. Historical data and past residual values help to reduce the inaccuracy but this can only be Image by Dave Dugdale possible for industries that have this historical evidence. 3
Depreciation Research Task Depreciation Research • You need to do some research on depreciation, bring your findings to the seminar. • What journals can you find that discuss how effective depreciation calculations are? • Find a sports case study where depreciation has been used in the accounting process and find out which method of depreciation is being used and why? PROPERTIES Allow user to leave interaction: After viewing all the steps Show ‘Next Slide’ Button: Show upon completion Completion Button Label: Next Slide 4
Analysing and Interpreting Financial Statements Classification The primary purpose of the income statement is to report a companies earnings to investors over a specific period of time. From this information financial ratios show the relationships between the figures and give further information to owners, investors and managers. The ratios focus on the following key area’s: 1. Profitability 2. Efficiency 3. Liquidity – meeting obligations 4. Financial gearing – contribution made by owners and ratio of lenders. 5. Investment – assessing returns. The balance sheet tells investors how much money the company has, how much it owes, and what is left for the stockholders. The cash flow statement is like the checking account; it shows you where the money is spent. The income statement is a record of the company's profitability. It tells you how much money a corporation made (or lost). Analysing and Interpreting Financial Statements Ratios Investors in Sports businesses will need to be able to calculate basic financial ratios. Ratios are used to evaluate the overall financial position of a corporation. You can assess the strengths and weaknesses of a company through the financial ratios. The ratios are used in accountancy by managers, owners and investors. Each party require different information as they have differing motivations. Ratio Analysis: 1. Past period – improvement over time? 2. Trends 3. Similar Businesses – operating in the same industry 4. Planned Performance – targets, benchmarks 5
Profitability Ratio Essentially profitability can be seen as the difference between the purchase price and the costs of bringing the product/service to market. 1. Return on ordinary shareholders’ funds 2. Return on capital employed 3. Operating profit margin 4. Gross profit margin Image by MyTudut Return on Ordinary Shareholders Funds The ROSF compares the amounts of profit for the period available to the owners with the owners average stake in the business. The Return On Shareholders Funds (ROSF) ratio has historically been used by industry investors as a measure of the profit for the period which is available to the owner’s stake in a business. The Return On Shareholders Funds ratio is therefore a measure of profitability ROSF = Profit for the year (net) less any dividend --------------------------------------------------------------------- Ordinary share capital + Reserves What does the Return On Shareholders Funds (ROSF) Ratio Mean to Industry and the Investor? Investors & the industry will look at the relative size of the Return On Shareholders Funds ratio. This is because a high ROSF percentage indicates that a company is profitable and has more profit available for shareholders. Why is Return On Shareholders Funds (ROSF) Considered Important? This is a narrower assessment of profitability (compared with ROCE) and therefore gives the investor a deeper insight into the profitability that they are concerned with. It is always critical to take professional investment advice before making any investment decisions. 6
Return on Capital Employed ROCE is a fundamental measure of business performance. Expressing the relationship between operating profit over a period and the average long-term capital invested in the business during that period. This ratio effectively measures the input and output and thus measure EFFICIENCY over a period of time of that business. ROCE = Operating Profit --------------------------------------------------------------------- Share Capital + Reserves ROCE compares earnings with capital invested in the company. It is similar to Return on Assets (ROA), but takes into account sources of financing. ROCE is used to prove the value the business gains from its assets and liabilities, a business which owns lots of land but has little profit will have a smaller ROCE to a business which owns little land but makes the same profit. Operating Profit Margin Focuses on the relation ship between profit and sales. Operational performance is used as a basis for comparison between types of business. For Example, sports equipment manufacturers might operate on low prices and thus look to function on low operating profit margins. This is done to stimulate sales and increase operational sales through volume sold. OPM = Operating Profit --------------------------------------------------------------------- Sales Revenue Factors that effect this ratio: degree of competition, type of customer, economic climate and industry characteristics. Operating margin is a measurement of what proportion of a company's revenue is left over after paying for variable costs of production such as wages, raw materials, etc. A healthy operating margin is required for a company to be able to pay for its fixed costs, such as interest on debt. 7
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