Assessing Company Value

When individuals are interested in purchasing, investing or working with a company it may also be a good idea to assess it’s financial status, using public information available through government sources, two documents can allow proper assessment. A statement of comprehensive income and a statement of financial position.

Company value calculations

Statement of comprehensive income

A statement of comprehensive income is a usually detailed report listing the inflows and outflows of capital of a business. They often include exceptional expenses and net profit for a business and subsequently can be difficult to follow but should provide a good understanding on how a business functions through the financial year.

Statement of financial position

A statement of financial position outlines the inventories, assets and equity a business has at the end of a year or season. It may also help to identify where most of a businesses cash is being spent or held in assets.

What are the benefits of these documents?

A statement of comprehensive income will help to identify the basic operations of a business, for example the yearly turnover. A company that makes more turnover than another, however may not be financially better or worse however as it can depend on how the money is used, fortunately there are many equations that can help us to define a standard for these figures that we can use to compare between businesses or yearly statistics.

Gross Profits

Gross profits allow us to determine how much profit a company makes after selling it’s products, this is already better than revenue as it shows that a company may be making a lot of revenue, but may be spending it all on sales. It is usually defined in the statement of comprehensive income.

Gross profit is Sales Revenue – Cost of Sales.

This figure is useful, but can be more effective when coupled with a percentage, as it is would allow us to compare for example previous years income, as below, it is for this reason we use the Gross Profit Margin to calculate a percentage.

Gross Profit Margin is (Sales Revenue – Cost of Sales) ÷ Sales Revenue. Higher is better.

BusinessGross ProfitGross Profit Margin
XYZ Telecoms$470,00051.32%
AB Telecom$460,00079.92%
AT TEL$430,00030.10%

As you can see from above the company XYZ Telecoms makes more money than AB Telecom however it is much more inefficient in it’s spending and therefore could reduce the cost of it’s sales to get higher returns. Note that although AB Telecom makes a higher Gross Profit Margin it does not make more money. Here is a breakdown of another Telecom company Telecomatic and they spend roughly 40% of their Revenue on sales, and therefore have a gross profit margin of 60%. In other words, if 40% is spent on sales, the company keeps the other 60% barring any other costs, like fixed costs.

RevenueCost of SalesGross ProfitGross Profit Margin
$100,000$40,000$60,00060%

Using gross profit and the gross profit margin is advantageous because it;

  • Enables you to calculate if spending on sales is too great.
  • Identify which company is better at sales spending.
  • Enables to identify if year on year a businesses spending on sales has been successful or not.
  • If there are two company chains, in two different locations with similar sales revenue, if they were to use different methods of advertising the sales profit margin would allow you to determine the best method based on the higher percentage.

However it does not;

  • Account for exceptional items or income.
  • Account for Fixed costs, such as machinery rent or leasing.

Operating Profits

Operating Profits are the next step of a businesses true income, operating profit accounts for overheads (expenses) that a business has to pay in order to function, expenses like factory ownership or employee pay and should easily be very close to a businesses true profit for the year if the business is new or homogeneous in nature. Operating profits however do not account for or should not account for;

  • Exceptional expenses, like purchasing new facilities or machinery.
  • Assets a business may hold of value.
  • Creditors.
  • Financial income or company dividend.

Operating Profit is calculated by Gross Profit – Overheads. Operating Profit Margin is calculated by (Operating Profit) ÷ Sales Revenue.

Yell TellThis year
Sales Revenue$848,100
Sales Expenditure$298,100
Gross Profit$550,000
Gross Profit Margin54.20%
Expenses$130,000
Operating Profit$420,000
Operating Profit Margin28.30%

Net Profit Margin

Lastly, for the comprehensive income sheet, the Net Profit Margin will show the overall effectiveness of the businesses expenditure. And represents how much raw profit a company makes based off its revenue, to put this into perspective its how much money is profit when multiplied by the turnover, so if a company’s net profit margin is 17%, and they turnover $1m a year, the company will have $170,000 unconditional capital left over at the end of the year barring complications.

The Net Profit Margin is calculated by Profit for the year ÷ Sales Revenue.

What actually is Marketing?

Marketing is Anticipating, and satisfying, customers wants and needs, efficiency and profitability, Marketing includes

  • Market Research
  • The Marketing Mix

What is the purpose of Marketing?

  • To make profit, essentially by improving sales
  • To remind the customer of your product through promotion
  • To see what the customer wants by offering their product
  • To link the product to the brand and create a brand association
  • To communicate and offer competition to other businesses (to compete)

There are two types of business orientations, Business to Business where businesses sell products to other businesses, such as tools, office equipment and building supplies. Business to Customer is more noticeable to individuals as it is more prominent and most common.

Marketing begins by setting a goal or objective that defines what the company wants to achieve, and when it hopes to reach these goals.

They then create a marketing strategy, to outline how they will bring in what they wanted to reach their objective.

the four ps of marketing product price place and promotion marketing mix

What defines a Market?

A market is anywhere that brings together buyers and sellers with a view of exchanging goods and services. The location can be physical, national global, physical or electronic.

A niche market is a small or select group of a larger market. Niche markets generally have a smaller cohort of customers interested in the product, however some businesses sell their products at a high price to compensate for lost sales.

Market size is the total volume or value of all sales of a particular group of products. Market growth is the percentage change in market size over a period of time. Market share is the percentage of the market achieved by one firm, or brand, or product.

Markets can be dynamic, which means they change quickly or stable, where any change is fairly small. Dynamic markets are becoming more and more common as technology advances to new greats, incorporating new techniques mean a business can become obsolete.

Kanban Systems in Lean Manufacture

Kanban systems in business allows them to effectively manage their stock internally, essentially for businesses that require large amounts of stock, such as small parts, screws or trolley-based workstations, they will likely use a Kanban system to effectively manage their stock. A typical Kanban asset tag will have the item description, part number and sometimes will include the cost of the unit, should the business want to try to regulate the use of the item.

What is the purpose of Kanban?

  • A Kanban system ensures that employees always have access to the tools they need and JIT systems can be implemented easily.
  • A Kanban system also allows a business to measure the amount of parts that they do not use when producing a product, and may be able to go to a smaller or higher quantity when ordering.
  • The tag system can also work with a three bin system, one on the factory floor, one in the re-stock room, and one at the supplier. This ensures that the bins are always stocked.
  • This system can also link in with other elements of lean production.
  • Defective products never make it to factory floor as they would not be stocked by the stock control system.
  • Some implementations have plates with the items needed laid out so workers can simply pick up the tools they need and assemble to product without having to move or find the item.
  • Some implementations also have the production line move along at the pace of the ordered quantity, making staff work harder to keep up with the product. (usually for production lines like planes or cars)

Kanban Asset Tag

kanban card system

Some businesses use the Average cost per unit to judge their effectiveness and efficiency, as Kaizen systems recommend ‘Continuous Improvement’ the average cost per unit provides a metric for them to calculate if they are more or less efficient.

Total production costs in period / Total output in period (units) = Average cost per unit

The rise of E-commerce (electronic commerce) and M-commerce (mobile commerce) has made the re-ordering process of these parts much more accessible for a company.

Factors Affecting Sales Forecasts

Sales Forecasts are charts and graphs, equations and educated predictions that allow businesses to predict future sales with a degree of accuracy.

  • Consumer Trends – People being proud of bargains and discounts. sales forecasts become harder to predict when consumerism changes.
  • Economic Variables – Recessions, Booms and Recovery.
  • Competitors Actions – loss leaders and pricing strategy may try to undercut you.
  • Digital Music for example, as become harder to predict as people have found new ways to obtain it illegally.
  • Fashion Items have an unpredictable life span.
Businesses use a range of forecasting tools to make forecasts

No single technique is reliable, but having multiple will allow you to better predict the future

Using sales forecasts may be useful but having data that is unreliable could mean that the forecast is not accurate. Making forecasts that are too long into the future could be considered extrapolation.

Extrapolation is cheap, although inefficient it gives a fixed perspective of what to expect which is better than nothing.

Planning for the worst allows companies to expect and anticipate failure. Very successful stable products cannot predict when sales will fall as their product is likely very price inelastic and customers are used to the product’s taste or function that changing it could make customers unhappy with the product. ‘Many financial measurements which are useful and valid in static situations are strategic traps in growth situations.’

sales volume over two years year end increase sales forecast shows volume

Failing to predict sales forecasts correctly

Failing to accurately predict sales forecasts may mean that a business could fail. Working capital is cash that is spent on the business, liquidity is not. Having a lot of working capital does not necessarily mean you are liquid. You may also have;

  • Contingency Finance (A financial Cushion)
  • Credit Periods yet to expire
  • An active Working Capital Cycle

That must be paid before you consider any additional finance as liquid that you can spend on anything.  Additionally when a business is in liquidation whereby they have had to cease trading there is still things that have to be paid off, and unfortunately for some employees, this may be unfair as it could mean a business cannot afford to pay them because they do not have the funds.

  1. The Tax Office must be paid, to cover the business from litigation.
  2. Shareholders must be paid dividends and the value of their shares.
  3. Employees must be paid their wages.

Some Key Terms

  • An Income Statement – Measures the business performance over a period of time, and may allow them to determine where forecasting was over-optimistic. It shows a companys revenue and total spending over a given period of time.
  • A Statement of Financial position is a snapshot of the business assets.
  • A Cash flow statement shows cash flow sources over a given period of time. It shows exactly how much a business has received and spent.

What is Break-even analysis useful for anyway?

What does Break-even calculate?

Here is a Break-even chart. It represents a 24 day period.

graph showing break-even anaylysis from 11 to 24 days
y = cash x = days

Break-even is when a business is not making any losses or profit, seen in the chart above at 11 days. It can be seen that the yellow total costs line, is the same angle as the variable costs line, plus fixed costs. It also can be determined, that the blue shaded are represents the magin of safety as after that all costs are paid.

What is Margin of Safety?

The margin of safety is how much additional units you have sold in a given period. For example, in the graph below, we are on our 18th day.

graph showing break-even anaylysis from 11 to 18 days

On this day we have spent approximately $680 since day 1, and by day 18, we have made $1040 revenue, so our margin of safety is $1040-$680= $360, however margin of safety does not work in money so we need to convert it back to units, so if each unit sells for $10, then our margin of safety is 36 units.

What is Break-even useful for? (Advantages and Disadvantages)

  • The point at which you aren’t making any losses or profit.
  • It allows you to identify problems you may face with cash flow on new investments, for example;
    • Investing in a more expensive warehouse may not be financially viable, as the investment would create a small margin of safety.
    • Increasing variable cost may make break-even harder to achieve.
  • It allows a business to ‘relax’ it’s workload after it has reached it’s margin of safety, as it no longer needs to cover costs. Everything made past the break-even point is profit.
  • It may allow an entrepreneur identify where they may want to take risks.
  • It also allows an entrepreneur to identify when a theorised project is not financially viable.
  • It focuses on what output is required before a business reaches profitability
  • Helps management and Finance providers better understand the viability of a risk or business idea.
  • It does not cater for potential changes in the moment
  • Unrealistic assumptions that everything stays the same.
  • It is more of a planning aid, than a decision tool.

However there are limitations of the chart, as it does not allow you to anticipate economy of scale, changes in fixed cost or demand. The most important factor that it allows you to calculate is the point that you aren’t making any losses or profit.

How is Break-even calculated?

 

 

Break-even Output = Fixed Costs / Contribution per unit


Contribution per unit = Selling price per unit - Variable cost per unit

or

Contribution per unit = Contribution per unit x Number of units sold