Balance Sheets (Review)

Transcription

1 ENGM 401 & X1 Fundamentals of Engineering Finance Fall 2010 Lecture 11: The Balance Sheet (2) "A bank is a place that will lend you money if you can prove that you don't need it." - Bob Hope M.G. Lipsett University of Alberta Balance Sheets (Review) Balance Sheets (Review) A balance sheet is a) An overview of a business s financial position for a reporting period. b) Usually done on the first day of an accounting period. c) Balances a business s current assets against its current liabilities plus owner s equity. d) Balances revenue and expenses. e) Gives an indication of a business financial position at a specific point in time. True or False: Owner s equity includes shares and retained earnings. MG Lipsett,

2 Working Capital Working Capital MG Lipsett, Working capital (WC) is the difference between current assets (CA) and current liabilities (CL) The extra cost of being in business over and above fixed assets A good measure of a company's efficiency and its financial health WC = CA - CL Working capital ratio is current assets divided by current liabilities WCR = CA / CL Adequacy of working capital is one key test for the provision of a short term credit line by a bank Positive working capital means you can pay off your short-term liabilities Negative working capital means you can t meet your short-term liabilities with your current assets Money tied up in receivables or inventory can t be used to pay obligations Reducing receivables and inventory is good for reducing CL, But when CL, CA also, and so WC is unchanged Working Capital (2) Working Capital (2) Working capital generally increases with sales level Typically, inventory, payables and receivables are proportional to sales Failure to recognize this has sunk many a business! Inventory and receivables are often measured in terms of days As a ratio of daily sales If your sales are $1,000 per day, and you have $30,000 in inventory, then you have 30 days of sales worth of inventory. Often in the 30 to 60 days range More businesses fail for a lack of available cash than for a lack of profit Novel one-time approaches are sometimes necessary to cover a major growth in sales. MG Lipsett,

3 Effect of Slow Payment & Inventory: Base Case Effect of Slow Payment & Inventory: Base Case Assets Liabilities Current Assets: Current Liabilities: Cash $ - Short Term Credit Line $ 400 Receivables $ 1,500 Accounts Payable $ 500 Short Term Investments $ - Accrued Expenses $ 50 Inventory $ 1,500 Taxes Payable $ - Prepaid Expenses $ - Cur.Por. of L T Debt $ 300 $ 3,000 $ 1,250 Fixed Assets: Long Term Debt: Land, Bld.& Cost $ 5,000 Repayable Grants $ - Less Acc. Depreciation $ 1,500 Long Term Debt $ 1,800 $ 3,500 Shareholders Equity: Long Term Investments $ - Capital Shares $ 3,000 Goodwill $ - Retained Earnings $ 450 Total Assets $ 6,500 Total Liab. and Equity $ 6,500 What s the effect when sales, receivables & inventory triple? MG Lipsett, Working Capital $ 1,750 Working Capital Ratio 2.4 Effect of Slow Payment & Inventory: Sales Triple Effect of Slow Payment & Inventory: Sales Triple Assets Liabilities Current Assets: Current Liabilities: Cash $ - Short Term Credit Line Receivables $ 4,500 Accounts Payable Short Term Investments $ - Accrued Expenses Inventory $ 4,500 Taxes Payable $ - Prepaid Expenses $ - Cur.Por. of L T Debt $ 300 $ 9,000 Fixed Assets: Long Term Debt: Land, Bld.& Cost $ 5,000 Repayable Grants $ - Less Acc. Depreciation $ 1,500 Long Term Debt $ 1,800 $ 3,500 Shareholders Equity: Long Term Investments $ - Capital Shares $ 3,000 Goodwill $ - Retained Earnings $ 450 Total Assets $ 12,500 Total Liab. and Equity $ 12,500 Working Capital $ 9,000 Working Capital Ratio #DIV/0! MG Lipsett,

4 Example: Working Capital Deficiency Example: Working Capital Deficiency Imagine a start-up magic box business with the following characteristics: Your rich uncle gave you $500k to see what you could do You and some friends spent two years and $400k doing the software Your losses to date from two years of prototyping are $95k Your sales strategy is a CM of 50% Material is 90% of COGS, contract labour is 10% You are selling $25k/mo of boxes to larger companies, who are testing the product. You are at break even One company gives you an order for $1,000,000!! Can you survive the order? MG Lipsett, Example: Working Capital Deficiency (2) Example: Working Capital Deficiency (2) The sequence of events: You order the material at time zero, terms net 30 You receive the material a month later You pay for the material on time You hire the labour force in month two to finish the product You ship the product at the start of month three, terms net 30. You book the earnings at this time Your large customer takes 60 days to pay, due to testing of the first large shipment Follow the balance sheets month by month Think like a banker MG Lipsett,

5 Example: Goodco vs. Badco Example: Goodco versus Badco Goodco and Badco have the same income statement for a one-year period: Revenue 650 Warranty/ Bad Debt 6 Net Revenue 644 COGS 320 Contribution Margin 324 CM, % 49.8% SG&A All admin except dep. 220 Depreciation 70 Operating Income 34 Other Income 12 Net Income 46 Retained Earnings, start 125 Net Earnings for the year 46 Less: Dividend Paid 16 Retained Earnings, end 155 MG Lipsett, Example: Goodco vs. Badco (2) Example: Goodco versus Badco (2) But, Goodco and Badco have very different balance sheets this year Goodco Badco Assets Current Cash Receivables Inventory Prepaids Total current Fixed Cost Less depreciation Net Total assets Goodco Badco Liabilities Current ST Credit Accounts Payable Accrued Expenses 9 9 Taxes Payable 2 2 Cur. Port. of LT Debt Total current Long Term Debt Shareholders' Equity Capital Shares Retained Earnings Total Liabilities plus Equity MG Lipsett,

6 Balance Sheets: Summary Balance Sheets: Summary A snapshot of the value of the business at a point in time Assets = Liabilities + Equity Assets are what the company owns Liabilities are what the company owes to others Equity is what the business owes the owners (both in capital shares and cumulative earnings retained in the business) Accurate only at that point in time (value constantly changes) Organized with most liquid items at the top (readily converted to cash) Credit worthiness is an issue Working Capital = Current Assets Current Liabilities Adequacy of working capital is a key test for lenders (Ability to pay of short-term loans, efficiency of the business) More business fail for lack of available cash than lack of profit MG Lipsett,