financial aspects

• Shareholder value


  The market value of a company's shares
• Cost of equity


  The return that shareholders require on their investment
• Free cash flow


  The cash flow from operating activities actually available for distribution to the shareholders
• Economic value added (EVA)

  A residual income measure that subtracts the cost of capital employed (shareholders' investment in the company, i.e. equity) from the operating profits generated in the company
• Market value added (MVA)

  The net present value of all future EVAs
• Main value drivers of free cash flow

  • Revenue
  • Operating costs
  • Tax
  • Working capital
  • Property, plant and equipment
• Gross margin


  (Revenue less cost of goods sold)/revenue
• Increasing positive cash flow has become an important success factor and a desired management goal
• Accounting measures, such as earnings per share, are only coincidentally related to share prices and not to the primary movers of share prices
• Investors have become increasingly aware of the fact that many accrual-based accounting measures do not provide a dependable picture of the future performance of a company
• The benefit of using free cash flow lies in the fact that it is not affected by changes in accounting methods for financial reporting purposes, whether mandated by the International Financial Reporting Standards or simply dictated by management choice
• An increase in the EVA will have a positive effect on the shareholders' value
• Negative EVA, where the cost of capital employed is greater than the net operating profit after tax, will erode shareholders' value, especially when it lasts for a long period of time
• Free cash flow is relevant when estimating the value of the shares in a company, as it represents the cash available to compensate shareholders, thereby creating shareholder value
• Satisfied customers attract other potential customers and are more inclined to place bigger orders with the supplier
• The lower the cost of goods sold in relation to the sales, the higher the gross margin
• Factors such as better training of workers and improvement in productivity should lead to a reduction in the wage bill, as employees can do more work, thereby increasing the gross margin
• Gross margin


  The ratio of (Revenue less cost of goods sold) to revenue
• Cost of goods sold

  Determined by raw materials used in production and other expenses incurred in converting raw materials into finished products, including labour costs, indirect costs and fixed costs like depreciation
• Reducing cost of goods sold

  1. Analyse direct and indirect costs of converting raw materials

  2. Improve worker training and productivity

  3. Better utilise raw materials to reduce waste

  4. Shorten supply chains to reduce duplication and react faster to demand changes
• Net profit


  Gross profit less expenses
• Primary activities


  • Inbound logistics
  • Operations
  • Outbound logistics
  • Marketing and sales
  • Services
• Support activities


  • Company infrastructure
  • Human-resource management
  • Technology development
  • Procurement
• Managing primary activities


  1. Inbound logistics: Manage materials handling, warehousing, freight in, admin

  2. Operations: Manage processing, assembling, testing, packaging

  3. Outbound logistics: Manage materials handling, warehousing, freight out, admin

  4. Marketing and sales: Manage sales force, advertising, promotion, admin

  5. Service: Manage installations, training, maintenance, returns
• Managing support activities


  1. Firm infrastructure: Manage general management, planning, finance, accounting, legal, government affairs

  2. Human-resources management: Manage recruitment, hiring, training, development, compensation

  3. Technology development: Improve product or primary activities, e.g. computerised order-entry

  4. Procurement: Manage purchasing of inputs used in value chain
• Tax


  Paid after calculating free cash flow, before dividends to shareholders. Opportunities to minimise taxes by considering location of assets, production and distribution
• Taxes payable by companies

  • Tax on profits
  • Tax on dividends declared
  • Property taxes
  • Taxes on fuel
  • Value-added tax
• Working capital


  Level required for efficient operation, e.g. sufficient inventory to avoid stockouts, not too stringent debtor collection to drive customers away
• Working capital cycle in manufacturing

  1. Order raw materials

  2. Receive raw materials

  3. Pay creditors

  4. Transfer raw materials to production

  5. Convert raw materials to finished goods

  6. Transfer finished goods to sales

  7. Sell finished goods on credit

  8. Receive cash from debtors
• Shortening working capital cycle

  • Reduce time from raw materials purchase to production
  • Reduce time to convert raw materials to finished goods
  • Reduce time to sell finished goods
  • Reduce time to recover cash from debtors
  • Extend time to pay creditors
• Cash


  Crucial to pay suppliers and avoid extending working capital cycle, which requires expensive short-term borrowing
• Accounts receivable/payable


  Shortening receivables period saves interest and enables faster creditor payments, also opportunity for cash discounts. Extending payables period also shortens working capital cycle.
• Inventories


  Consist of raw materials, work in progress, finished goods. Monitoring and managing inventory levels has major impact on profitability.
• Property, plant and equipment

  Efficient deployment and utilisation is crucial, company may outsource production/distribution to move assets off balance sheet and focus on primary activities. Return on assets must exceed financing costs.
• Return on investment


  Objective is to increase return on assets, which directly impacts return on equity
• Managing return on equity

  1. Increase return on assets

  2. Increase assets to equity ratio
• Profit margin


  Net profit divided by sales, indicates how well production costs are managed
• Cost of sales


  Calculated from raw materials used, labour costs, and overheads. Strategies to reduce these costs.
• Expenses


  • Marketing and distribution costs
  • Administrative expenses
  • Other operating costs
  • Interest payable
  • Taxation
• Asset turnover


  Indication of how effectively assets are utilised, both non-current and current assets