Financial Management 101
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Transcript of Financial Management 101
Financial Management 101• Source of Funds
• Sales Vs Profit
• Cashflow Management
• Debt Management
State Funded Regional Allocations
0
50
100
150
200
250
300
PacificM/way
SEQ SQ CQ NQ
2000-012001-022002-03
Sources of Main Roads Funding ($M)
261
19
3
8
21
19
834
Federal NationalH/waysFederal RoNI
1st Qtr
Federal Black Spot
Natural Disaster Relief
Private DevelopmentContributionsState Funds
Allocation of Main Roads Funding ($M)
522
313
65
52
118
95Construction
Rehab & Mtce
Regional P&P
Local Gov Subsidies
Corporate & TechnicalOutputsDebt Servicing
Sales vs. Profit Margin
The predominance of the Sales Paradigm
• Sales/turnover myopia
• The busy fool
Many think as follows:
• Sales = Income More is better
Gross margin
• Profit Margin = Income
Profit Margin is the only income of the business
Sales/Turnover
Sales are only a way of keeping score
Reference: Peter Knight, Hayes Knight Partners
Question: How many of you are stuck in the sales paradigm?
The power of the gross margin
Example Price decrease = 5%
Gross profit decrease = 50%Gross profit goes from $10 $5
•Consider effect of price decrease on number of sales
•Effect on cash
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30405060
708090
100
110120130
Gross Profit $10 Gross Profit $5
Val
ue
$ Gross Profit
COGS $90
Example Price increase = 5%Gross profit increase = 50%
The power of the gross margin
Gross profit goes from $10 $15
•Consider effect of price increase on number of sales
•Effect on Cash0
102030405060708090
100110120130
Gross Profit $10 Gross Profit $15
Val
ue
$ Gross Profit
COGS $90
Pricing
1) Profit =
2) Profit margin % =
3) Target revenue =
Revenue - COGS -Overheads
Profit margin
ProfitRevenue
Profit
PricingExercise 1: “The Sales Paradigm”
In 2000/2001 financial year a Business Unit of Commercial Operations had a turnover of $100M and achieved a profit margin of 2%. What is the dollar value of the profit achieved for the 2000/2001 financial year?
ANSWERANSWER
Profit = Revenue x Profit Margin
= $100,000,000 x 0.02
= $2,000,000
PricingExercise 1: (Cont)
Now let’s explore the effect of pricing on sales. You have been recently appointed to the position of Director - Asset Services (South) and currently you are preparing your budget for 2002/2003 financial year. As Director, you are required to contribute a net profit to the business of $2M. After discussions with the Regional Executive Directors for Southern and South East Region you believe that it would be possible to achieve a profit margin of between 2 – 5%. What level of revenue should you budget if you are able to achieve a profit margin of 2%, 2.5%, 3.0% and 5%?
Pricing ANSWERANSWER
We Know: Profit = Revenue - Expenses
Profit Margin = Profit Revenue
Therefore: Revenue = Profit
Profit Margin2% Profit Margin
Target Revenue = $2,000,000 = $ 100 M0.02
2.5% Profit Margin Target Revenue = $2,000,000 = $ 80 M
0.0253% Profit Margin Target Revenue = $2,000,000 = $ 67 M
0.035% Profit Margin Target Revenue = $2,000,000 = $ 40 M
0.05
Pricing So What?So What?
• What can we do with this information? • What impact does this have on the Source of Funds from
the RIP?• Does more sales mean better?• What is the impact of Fixed costs of the business (eg Fixed
Labour Costs, Overhead Costs)?
Gross margin is the true income to the businessGross margin is the true income to the business
Exercise 2: “The effect of pricing on profit margin” In your notes is the MIS (Management Information System) report for RTCS Statewide. This report highlights a number of key financial indicators. Question:Review the “Winning Margin” financial indicator and determine the cash effect to the business if the actual “Winning Margin” was 2%. The term “Winning Margin” represents the percentage margin between the tendered price that won an open market job and the tendered price that came second. In other words it represents the percentage of money left on the table for an open market job.MIS Report states:Winning Margin: Actual is 5.9%, Budget is 6.3%Work Won: Actual is $45.2M, Budget is 47.7M
ANSWERANSWER Cash EffectMoney Left on the Table: @ 5.9% = $45.2M x 5.9%
= $2.66M (left on the table) @ 2% = $45.2 x 2.0%
= $0.9M (left on the table) @ 5.9% - 2% = $45.2M x 3.9%
= $1.76M
What does this represent in terms of revenue? Revenue Lost = Profit
Profit Margin
= $1.76M2.0%
= $88M
Pricing
• Total RoadTek Turnover for 2000/2001 was $280M • Lost Revenue of 31% of annual turnover
What does that mean? RoadTek could have priced only $192M of work and still achieved the samelevel profit.
The business cash cycle: Key themes The time, value of money Working capital – preventing bloat in
working capital: Debtors Creditors Time
How to achieve timely payment using: Invoicing Servicing delivery Reducing disputes
Value-adding management Reducing cash cycle times Focusing on tasks
Creditor management Creditor strain Settlement discounts
Cash
Stock equipment
MarginSales
Receivables
Cash: Managing cash
PositivPositive effect e effect on cashon cash
Above the line measures• Increase gross margin (do not discount)• Focus on value added per unit of time or
unit of space measures• Focus on reducing costs of goods sold to
increase price• Rationalise product range – drop low
margin products
Below the line measures
• Aim to reduce breakeven sales level by reducing overhead costs
Balance Sheet
Stock• Minimise amount and time held
Work in progress• Focus on job velocity• Shorter turnaround• Quicker invoicing
Debtors• Manage debtors• Stick to terms and enforce them• Recognise your benchmark
Creditors• Avoid creditor strain • Pay in a timely manner
Consider:
Sales Terms 30 days net
Cash cycle: Controlling cash
Sales during the month on credit
Customer pays
1 Sept
30 Sept
31 Oct30
days“30
days”
Calculating benchmarks: Debtors as a % of sales
Reference: Peter Knight, Hayes Knight Partners
Basis of calculations:
No. of days credit given x 100
No. of days in one year
Eg. 60 days credit given:
60 X 100 = 16.4% say 16%
365
Credit given Benchmark7 days 2%14 days 4%30 days 8%45 days 12%60 days 16%75 days 21%90 days 25%
105 days 29%120 days 33%
Calculating benchmarks: Debtors as a % of sales
Reference: Peter Knight, Hayes Knight Partners
Exercise 3: “Debtors as a % of sales”
As at 31 December 2001 the RTCS Business Group reported Accounts
Receivables of $25.1M with an estimated annual turnover of $280M.
What is the % Sales in Debtors and is this result reasonable?
% Sales in Debtors = Accounts Receivables
Annual Sales
Calculating benchmarks: Debtors as a % of sales
Reference: Peter Knight, Hayes Knight Partners
ANSWERANSWER % Sales in Debtors = Accounts Receivables
Annual Sales
= $25.1$280
= 9.0%
This represents average days of credit given of 33 days.
Debt Recovery
Exercise 3: “Debt Recovery”
You have a bad debt of $10,000 and have exhausted all options of recovering the debt and the debt is written off.
What amount of additional revenue must be generated to break even and recover this loss.
Assume your profit margin is 2%.
Reference: Peter Knight, Hayes Knight Partners
Debt Recovery
ANSWERANSWER
Revenue = Profit
Profit Margin
= $10,000
0.02
= $500,000
Reference: Peter Knight, Hayes Knight Partners
1) Buying/investing in stock “just-in-time”
Making a start
Check your stock level (raw materials) against the benchmark data
Establish where you are now and work on it (use the measure as a guide to progress)
Suggestions:
• Consider free in to store system, i.e. suppliers keep you stocked and charge only what you use
• Carefully consider bulk buying discounts – calculate the true cost using a discount rate formula e.g. value of stock + interest paid on funds under to purchase and hold for the period (N.B. use your overdraft interest rate)
• Consider implementing “just-in-time” system with a dedicate supplier for major inputs
Shortening the cash cycle
Reference: Peter Knight, Hayes Knight Partners
Shortening the cash cycle
Reference: Peter Knight, Hayes Knight Partners
2) Focus on job velocity
Making a start Identify main products or services Follow each through the various value-adding processes in the business Map out the process and record times taken and delays Measure value-adding time and measure non value-adding time. Establish
the value-adding ratio (value-adding time/none value adding time) Use this information to achieve a better result
Suggestions• Involve staff in key areas in identifying product/service process flows• Identify areas of delay and concentrate on the largest first• Use measures such as value-adding ratio and time taken, as a guide• Consider sub-contracting if you are inefficient in areas
Shortening the cash cycle3) Invoicing effectively
Making a start Balance efficiency with effectiveness, i.e. invoice to get paid as soon as possible
(efficiency may dictate invoicing in bulk at month’s end – is this effective?). Recognise the “Gratitude Concept”
Suggestions• Invoice when tangible value is delivered• Plan jobs with invoicing points in mind, based on identifying gratitude points
Gratitude
Time
Job completion/value delivered
Invoice here for quick payment
Reference: Peter Knight, Hayes Knight Partners
Shortening the cash cycle4) Receivables and terms of tradeMaking a start
Review your debtors against benchmark Review your terms of trade and performance If performance is below benchmark? Look at:
• Debtor awareness• Invoicing – Timing of invoices• Debtor follow-up/terms enforcement
Develop a debtors management system Document procedures and train staff
Suggestions• Review current procedures• Develop strict procedures for querying all accounts outside your terms• Stick to your terms and enforce where required• Review job commencement procedures to ensure terms are explained and given
importance• Monitor receivables systematically (at least weekly)
Reference: Peter Knight, Hayes Knight Partners
Cash cycle: Key principles summarised
Bloat or blow out in working capital is caused by: Too much stock
• Raw materials• Finished goods• Billable hours
Debtors too high Poor creditor management Poor cash management
Reference: Peter Knight, Hayes Knight Partners
Cash cycle: Key principles summarised
How to shorten the cash cycle:
1. Buy/invest in stock “just-in-time”2. Focus on job velocity, i.e. shorten the value-adding time3. Invoice on completion or at key points on the gratitude curve4. Focus on receivables and terms of trade5. Always consider the time value of money
Reference: Peter Knight, Hayes Knight Partners
Cash cycle: Key principles summarised
DepreciationDepreciation
Fixed Assets are Resources
Their Earning Capacity Reduces over use and time
Depreciation is a measure in the reduction in capacity of the assets
No reduction in cash
Reduction in asset worth
What Happens to the WealthDividends Return to the Owner Reduces Net worth / Equity Reduces Resources (CASH)
OR Reinvest No Change to Net Worth No Reduction of Resources Resources are Available to Build the Business