Must Have Tools in the Cooperative Finance Professional Toolbox. NSAC/NRECA TFACC August 5 & 6, 2018 Austin, Texas

Transcription

1 Must Have Tools in the Cooperative Finance Professional Toolbox NSAC/NRECA TFACC August 5 & 6, 2018 Austin, Texas

2 Introduction Financial management numbers, ratios, analysis, common sense Financial ratios the details, the backing for analysis and decisions Gain better understanding of the ratios, improving management Share experiences and make and implementation plan Practice! Examples!

3 Role as a Finance Professional Produce accurate and timely financial reports Provide information to others for decision making Forecast the future Interpret financial results and recommend options Be a trusted financial advisor that can explain financial results in a simplified manner Present and convey financial messages for your organization

4 Financial Management - Looking beyond the numbers Are your revenues tied to one key member/customer? Are your revenues tied to one key product? To what extent does the company rely on a single supplier? What percentage of your business is generated overseas? What or who is your competition? What are your future prospects? What is the legal and regulatory environment?

5 Discussion! What are your Opportunities and Threats? Discuss with those around you

6 Discussion! What are your Opportunities and Threats? Regulation Technology Renewable energy Alternatives Limited resources Costs Environmental concerns Competition Human resource challenges Legal Implications Diversification Acquisitions/Mergers

7 Financial Management Measurements

8 Workshop Outline Topic 1: Financial Measurements Return on Equity Du Pont equation = Return on Assets (ROA) Equity Multiplier Benchmarking and comparative ratios Topic 2: Cash Flow Free Cash Flow Cash Flow Replacement of assets Topic 3: Investments Rate of Return Expected Rate of Return Topic 4: Time Value of Money Present Value Discounting of Capital Credits Weighted Average Cost of Capital Cost of Debt Return on equity Topic 5: Capital and Long Term Planning Project Cash Flows Payback Net Present Value(NPV) of cashflow Internal Rate of Return (IRR) Debrief

9 Topic 1 Financial Measurements Return on Equity DuPont Equation Equity Multiplier Benchmarking and comparative ratios

10 Return on equity Total Margins Return on Equity (ROE) = Equity Value This is your increase in equity as a percentage. Given margins for the year.

11 Du Pont equation Same thing as ROA Return on Assets Result is the rate of return on assets Return on Assets (ROA) = Profit Margin X Total asset turnover Net Income Sales Return on Assets (ROA) = X Sales Total Assets

12 Equity Multiplier The inverse of Equity/Asset Ratio Instead Assets/Equity The more debt financing of your organization, the higher the equity multiplier Total Assets Equity Multiplier = Equity

13 Benchmarking and comparative ratios Ratio Analysis is not complete without Trending your numbers Comparing your ratios to others like you in the same industry Considering industry averages Benchmarking Taking specific results of others and comparing them to your numbers Neighbors Same size Same sales mix Stack your numbers up to others Cooperative advantage is that we can ask questions and share!

14 Topic 1: Practice!

15 Topic 1: Practice Answers

16 Topic 2 Cash Flow Free Cash Flow We do not have the cash to pay capital credits? one of the most common board comments Cash Flow Analysis Replacement costs

17 Free Cash Flow Net Income (Margins) plus non cash adjustments to Income Statement Operating Cash Flow Depreciation and Amortization Patronage Allocations Other? Operating Cash - This is the cash available Then subtract investment in depreciating fixed assets Consider industry. What is the split (60/40, 100) = Free Cash Flow Cash Available to pay investors

18 We don t have any cash to rotate/pay capital credits Cash Flow versus Accounting Income Accounting Income Reduce for patronage allocation income Increase for depreciation Pay portion of fixed assets equivalent to our equity position (45%) What cash remains? Often we have paid more towards our fixed assets and have not drawn down debt.

19 Cash Flow Analysis Replacement Project Replacement decisions - consider old and new assets Cost of new equipment Value of old equipment Change in depreciation Reduction in costs = Net operational efficiency Estimation is critical. Estimation is the most difficult part Biases - overly optimistic, emotional attachment If a Zero NPV is calculated, statistically it is likely going to be a loss

20 Topic 2: Practice!

21 Topic 2: Practice Answers

22 Topic 3 Investment Measurements Rate of Return Expected Rate of Return

23 Rate of Return Business or Person invests $$$ Money Expectation they will earn on their money and have more in the future Return is the expression of the financial performance Dollar Return Rate of Return Standardizes the return by considering the return per unit of investment Past tense when we have the input factors Most common measure of investment performance Examples Dollar Return = Amount Received - Amount Invested Rate of Return = Amount Received - Amount Invested (Dollar Return) Amount Invested

24 Expected Rate of Return Brings probability into our outcomes And sums those probabilities = weighted average of outcomes Called k-hat or a payoff matrix Probability and Expected Rate of Return Possibility Probability Rate of Return Product Strong 30% x 100% = 30% Normal 40% x 15% = 6% Weak 30% x -70% = -21%

25 Topic 3: Practice!

26 Topic 3: Practice Answers

27 Topic 4 Time Value of Money The impact of time and interest Present Value Discounting Weighted Average Cost of Capital Cost of Debt Cost of Equity Application of concepts

28 Time Value of Money - Interest You will receive $50,000 in 3 years if you invest at 6% How much do you invest today? $50,000 / 1.06 = $47,170 $47,170 / 1.06 = $44,500 $44,500 / 1.06 = $41,981 Time 3 Years Interest 6%

29 Time Value of Money Present Value A dollar today is worth more than a dollar received at some future time. If you have $1,000 today and are able to keep it, you will have more than $1,0000 on some specific future date (interest). If you have the option of a present value of $300,000 today or $500,000 in 5 years, they should be the same thing. Present Value 1 Future = X Value (1+rate) time

30 Discounting Process Present value, interest rate, time Present value of $1,000 diminishes as the years to receipt and interest rate increase Opportunity Cost = interest rate

31 Discounting Process Present value, interest rate, time Opportunity Cost = Interest Rate Each objective should be concise, should contain a verb, and should have a measurable result.

32 Discounting Example Time = 5 years Discount rate = 5% Future value =$ What is the present value? $100 Interest Rate 5% 5% 5% 5% 5% 5% Time Cash Flow $100 - $ 100 Present Value /1.05 /1.05 /1.05 /1.05 $100/1.05% Interest Rate 5% 5% 5% 5% 5% Time Cash Flow $ 3.89 $ 4.09 $ 4.31 $ 4.54 $ 4.76 $ 100 Present Value $ $ $ $ $ $ 100 Present Value = FVn = $100 = $100 (1+i) n (1+5%) 5 (1.05) 5

33 Discounting of Capital Credits Total Allocated Patronage $ 25,000 Discount Value $14,094 Co-op Equity Less bad debt ($500) $ 10,906 Net amount to pay $13,594 Year Allocated $$ Allocated Year Retired Refund $ to based on Member based rotation on discount % Cooperative $ retained as Equity Required Input $ 1, $ $ $ 1, $ $ Enter most recent year $ 1, $ $ an allocation was made $ 1, $ $ $ 1, $ $ Required Input $ 1, $ $ $ 1, $ $ Enter Rotation Period 25 years $ 1, $ $ Enter rotation policy or calculated rotation(if hybrid) $ 1, $ $ $ 1, $ $ Required Input $ 1, $ $ $ 1, $ $ Choose Discount rate 5.000% 5, $ 1, $ $ Coop determines this rate $ 1, $ $ $ 1, $ $ Required Input $ 1, $ $ $ 1, $ $ Enter Capital Credits $ 1, $ $ (Enter in Green cells) $ 1, $ $ $ 1, $ $ Per Cooperative Policy $ 1, $ $ $ 1, $ $ Enter bad debt amount $ $ 1, $ $ Per your cooperative's policy $ 1, $ $ $ 1, $ $ $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ - $ -

34 Total Allocated Patronage $ 25,000 Discount Value $14,094 Co-op Equity Less bad debt ($500) $ 10,906 Net amount to pay $13,594 Year Allocated $$ Allocated Year Retired based on rotation Refund $ to Member based on discount % Cooperative $ retained as Equity Required Input $ 1, $ $ $ 1, $ $ Enter most recent year $ 1, $ $ an allocation was made $ 1, $ $ $ 1, $ $ Required Input $ 1, $ $ $ 1, $ $ Enter Rotation Period 25 years $ 1, $ $ Enter rotation policy or calculated rotation(if hybrid) $ 1, $ $ $ 1, $ $ Required Input $ 1, $ $ $ 1, $ $ Choose Discount rate 5.000% 5, $ 1, $ $ Coop determines this rate $ 1, $ $ $ 1, $ $ Required Input $ 1, $ $ $ 1, $ $ Enter Capital Credits $ 1, $ $ (Enter in Green cells) $ 1, $ $ $ 1, $ $ Per Cooperative Policy $ 1, $ $ $ 1, $ $ Enter bad debt amount $ $ 1, $ $ Per your cooperative's policy $ 1, $ $

35 Weighted Average Cost of Capital Combines Cost of Equity and Cost of Debt Factors Interest Rates (cannot control) Capital Structure Policy (can control) Capital Credit Rotation/Return Policy (can control) Capital Investment Policy (can control) Interest Rates Capital Structure Policy Capital Credit Rotation/Return Policy Capital Investment Policy Cost of Equity % Cost of Debt % WACC *Weighted by the proportion of Debt and Equity in the Capital structure

36 100% WACC 6.35% Weighted Average Cost of Capital WACC Computation Weight Component x Cost = Product Debt 60% 5% 3.00% Equity 40% 8% 3.20% 100% WACC 6.20% What if your equity position changes? Debt 55% 5% 2.75% Equity 45% 8% 3.60%

37 Cost of Debt Loan 6 Loan 5 Loan 1 Cost of Debt Loan 4 Loan 2 Loan 3

38 Cost of Equity Growth (Assets or Plant) Cost of Equity Equity Rotation

39 Topic 4: Practice!

40 Topic 4: Practice Answers

41 Topic 5 Capital and Long Term Planning The value of a capital budgeting process The process Project cash flows Payback Net Present Value (NPV) Internal Rate of Return (IRR) Debrief

42 Capital Budgeting Most important function of financial manager and staff Investment in fixed assets cause the organization to lose flexibility An erroneous forecast of asset requirements can have serious consequences High depreciation High interest costs Operational cost savings or losses Timing is everything Plan ahead so cash needs support the capital budget needs

43 Capital Budget process 1. Cost of project determined 2. Management estimates expected cash flows, salvage value 3. Riskiness of the projected cash flows estimated 4. Riskiness determines the cost of capital 5. Expected cash flows are put on a present value basis to estimate value 6. Present value of cash flows is compared to the required outlay of cash If PV exceeds costs Go! If PV is less than costs No Go! Is that how it really works for us?

44 Project Cash Flows Year (t) Project A Project B Project A Project B

45 Payback period of cash flows Year (t) Project A Project B Project A Project A Payback Project B Project B Payback

46 Net Present Value of Cash Flows Net Present Value CF 1 CF2 CFn Cash = Flow 0 (1+rate (k)) 1 (1+rate (k)) 2 (1+rate (k)) n

47 Internal Rate of Return The IRR ratio can be employed for either calculating promised cash flows on a bond or for capital budgeting It s the discount rate which equates the present value of a project s expected cash flows. Which can then be compared to a project cost Need to use a financial calculator can t be done by hand (trial and error) The IRR of a project is the expected return (%) on the project Using NPV ($) or IRR (%) will ALWAYS yield you the same answer regarding the project you are assessing.

48 Now that the Capital Budget process is over. Post Audit Debrief! Improve forecasts Improve operations Identify abandonment/termination opportunities

49 Topic 5: Practice!

50 Topic 5: Practice Answers

51 Summary of Training As a result of this course, hope to move your analytical skills Produce accurate and timely financial reports Provide information to others for decision making Forecast the future Interpret financial results and recommend options Be a trusted financial advisor that can explain financial results in a simplified manner Present and convey financial messages for your organization See the value of using financial management measurements in decision making You have a resource you are comfortable referring to You can phone a friend to talk (me or your table neighbors)

52 Assessment and Evaluation Please complete the Survey!

53 53 Thank you for spending your afternoon learning and improving the financial management of your organization!

54 Training & Education, Consulting Services Check out website terilynwallisconsulting.com Like my Facebook Page Terilyn Wallis Consulting Accounting and Finance Workshops At Statewide events At Board tables At Regional Events Consulting Services Finance/Accounting Strategy, Planning and Risk Mitigation Forecasting and Analysis Board and CEO evaluations Outboarding of CFO s for success

55 Topics provided by Terilyn Wallis Consulting Work Order Accounting Utility Accounting Basics and Advanced Financial Tools for the Toolbox Equity Management and Capital Credits Policies Process Improvement Case Study Scenarios Development of Team (Real Colors Personal Success) Management Development (Emotional Intelligence) Defining your Leadership Style