Appunti del corso Business economics and organization

Business economics and organizations

Accounting and budget analysis

Digital transformation

Physical vs digital: Convergence P=D, Smartification P+D, Virtualization P D. Digitalization and connectivity: blending of digital and physical. Digitization + Connectivity = Digitalization Process. Digitalization ≠ Digitization. Digitization is the process to transpose a physical information into digital. Connectivity relates digital artifacts with each other. Digitalization is the practice of using technology to enhance corporate processes. In synthesis, digitization relates to information, whereas digitalization relates to processes.

Digitalization is related to:

• Customer engagement – the more you engage, the more you sell; higher customer satisfaction.
• Marketing – using digital for marketing purposes.
• Operations – to increase productivity, efficiency.
• Work practices – to reduce time losses.

Business model: value creation and value capture, by reducing complexity through standardized components and formalized processes, through horizontal complementarities within the ecosystem, by experimenting at the crossroads of the digital and physical world, through convergence in stakeholders' interests.

Customer engagement vs customer centric

Customer engagement focuses on Products (Market Research – Product – Engagement). Customer centric focuses on Needs (Engagement – Needs – Solution).

What digital transformation is?

Technology-enabled, multi-level change. What should organizations do? Digitalization, "as-is" efficiency (very short lived). Digital innovation, doing some activities differently. Digital transformation, adaptation to the new environment. Value from connecting the dots – Platforms. Value from making the dots – Specialists. The possible winning formula? Blending digital and physical objects, maintaining the uniqueness of the physical assets but giving them a proper digital identity, to address the new customers' needs.

The nature and purpose of accounting

The need for information

Organization / Company / Enterprise: Groups of people who determine to cooperate permanently to achieve common and individual goals. To operate effectively, enterprises need information and financial capital. The enterprise uses technical and human capital along with external services and assets to organize the production process. Accounting provides much information that people use to manage and evaluate businesses.

Four types of accounting

• Financial Accounting – to support the decision-making activities of internal actors, to support external actors' decisions, and to provide information relevant for the preparation of the company's financial statements.
• Management Accounting – to support managers and their planning and control activities within the company.
• Operating Information – has to do with the details of operations.
• Tax Accounting – used to file tax returns.

The conceptual framework governing accounting and budgeting

The basic rules and concepts of accounting are defined principles, general rules that guide enterprises to communicate reliable, relevant, and comparable information. The 3 general criteria for the formulation of accounting principles are:

• Relevance – a principle is relevant if it produces important and useful information about a company.
• Objectivity – a principle is objective if it produces information that is not influenced by those who produce it (reliability and verifiability).
• Feasibility – a principle is feasible if it can be implemented without excessive cost or complexity.

The 5 Principles of Financial Accounting are:

1. Homogeneity – the accounting records refer only to events that produce effects that can be expressed in monetary terms.
2. Continuity of Operation – unless there is clear evidence of the contrary, in preparing the financial statements it is assumed that the company will continue to operate for an indeterminate period.
3. Periodicity – it’s required to give away information regarding the company at frequent and periodic intervals over time. Accounting measures the economic result of a specific period called the administrative period or financial year.
4. Historical Cost – the economic resources of a company are called assets, accounted for at its purchase price, the historical cost. Non-monetary assets are always accounted for at historical cost. Monetary Assets are initially accounted for at historical cost and in some cases modified to estimated "fair value" (market value or current value at which an asset can be sold, influenced by depreciation). The cost principle does not mean that the value of non-monetary assets remains indefinitely the initial one. The cost of assets that have a multi-year economic life is systematically reduced over time through a process known as depreciation. Depreciation is a systematic and rational process through which the purchase cost is transformed into costs for doing business to jointly take into account the functionality lost (obsolescence) and the service provided during the period of operation. Depreciation is NOT the loss of market value that the asset suffers during the period.
5. Double Aspect – Rights to corporate assets belong to two categories:
   • Liabilities, which represent the rights claimed by creditors.
   • Owner's Equity, the rights claimed by the property. It follows that: Assets = Liabilities + Owner’s Equity. The Owner’s Equity is a residual value, any asset on which creditors have no rights will be claimed by the property. The condition exists even if the liabilities are greater than the assets – the equity would assume a negative value.

Any event that changes a company’s accounting values is called a transaction. Each transaction changes at least two balance sheet items.

The financial statements

The financial statements are made up of 4 main documents drawn up on a period basis:

1. The Balance Sheet – Statement of the financial situation at a given time, represents a "snapshot". It’s composed by Assets, Liabilities and Owner's Equity.
2. The Income Statement – Account of the activities carried out over an accounting year, measured as revenues minus expenses. It represents a "flow" document.
3. The Cash Flow Statement – Not mandatory for unlisted companies, represents the change of the cash balance in/out flows in operating, financial and investing activities.
4. The Statement of Retained Earnings – the change of retained earnings (+net income, -dividends).

Balance sheet

The balance sheet is divided into two sections:

• The Assets on the left.
• Liabilities and Owner’s Equity on the right.

All values are expressed in monetary terms ($). The Assets represent the economic resources of a company. To be considered as such, they must have been acquired through a transaction.

The Current Assets are:

• Cash and Cash Equivalent – Funds that are readily available for disbursement.
• Short-Term Investments – Investments that are both readily marketable and expected to be converted into cash within a year.
• Accounts Receivable – Amount owed to the entity by its customers.
• Inventories – Aggregate of items that are either held for sale, in process of production for such sale or raw materials soon to be consumed in the production of goods or services that will be available for sale.
• Other Current Assets – Assets usually of intangible nature, whose usefulness will expire within a year.

The Non-Current Assets are:

• PPE (Property, Plant and Equipment) – Assets that are tangible and relatively long-lived, depreciated except for lands.
• Investments in Financial Assets – Securities of one company held by another or the purpose of controlling the other company.
• Intangible Assets – Goodwill, patents, copyrights, trademarks (Goodwill represents the value of the name, reputation, intellectual capital, brand customers, or similar intangible resources of the purchased company).

The Liabilities are obligations and debts to pay to third parties. Current Liabilities are obligations that are expected to be satisfied within one year and are made up by:

• Current Debt – Amounts owed to financial institutions.
• Account Payable – The claim of suppliers or vendors for the payment of goods or services not yet paid.
• Deferred Revenues – The liability that arises because the entity has received advanced payment for a service it has agreed to render in the future.
• Other Current Liabilities – Wages owed to employees, etc.

Non-Current Liabilities include mortgages, bonds, pension funds, etc.

The Owner’s Equity shows the amount the owner has invested in the company. The main elements of the Owner’s Equity are:

• Common Stock – Amount the owner has invested directly into the business by purchasing shares of stock.
• Retained Earnings – The cumulative amount that has been retained in the business from the beginning of the corporation up to date (difference between the total earnings and the total amount of dividends paid out to its shareholders over its entire life).

Income statement

The Income Statement reports the results of operations and explains how the company generated wealth or losses. It shows in detail the cost and revenue elements that led to the retained earnings. The elements of the Income Statement are:

• Revenues – Inflows of assets that result from the sale of goods and services to customers.
• Accrued Costs – Outflows of resources that were required to generate these revenues.
• Net Income (or Net Loss) – the difference between revenues and accrued costs. Net Income ≠ Revenue; Net Income ≠ Cash.

More in detail, the Income Statement is composed of:

• Sales Revenue – Value of products and services sold to customers during the period.
• Cost of Sales – Its definition varies depending on the type of company. For a production company, it’s the cost of resources directly attributable to the goods or services sold. For a commercial company, it’s the purchase cost of the goods sold.
• Gross Margin (or Gross Profit) – Represents how much the company earns before covering all other costs other than the cost of sales.
• Operating Expenses – Consists of Research and Development, Selling General, and Administrative.
• Operative Income – The difference between Gross Margin and Operating Expenses.
• Non-Operative Expenses (+Interest Expenses) – Cost of financial debt incurred using third-party money (interests on loans, mortgages).
• Pretax Income – The difference between Operating Income and Non-Operating Income/Expenses and Interest Expenses.
• Tax Provision – Amount of taxes to pay based on a set percentage of the Pretax Income.
• Net Income (or Net Loss) – Difference between Pretax Income and Tax Provisions.

The Intermediate Incomes improve the understanding of the company’s economic situation and how the income was generated. For the same Net Income:

• Having achieved it from the Operating Income is a predictor of a good future economic performance.
• Having achieved it because of an exceptional capital gain (as a Non-Operating Income) could have the opposite interpretation.

Financial statement analysis

The financial statement analysis describes how the information contained in the BS and the IS is analyzed by management and third parties. Let’s remember that the primary purpose of a business is to:

• Create value for its shareholders.
• Preserve a secure equity and financial position.
• Have a satisfactory relation/performance with all stakeholders.

Profitability ratios

The Profitability Ratios are related to the company’s ability to earn profit with an efficient use of the resources available. The Profitability Ratios are: ROE, ROA, ROI, ROS.

1. ROE (Return on Equity) – Measures the return on the investment of the ownership during a fiscal year. It’s a major indicator of interest for current and potential shareholders. If ROE > Government Bonds, the company has a good return on capital, so it’s convenient to invest in it. If ROE < Government Bonds, the company is not profitable enough. If ROE < 0:
   • OE < 0, shareholders owe money to the company
   • Net Income < 0, Net Loss
   Worst case is ROE > 0, OE < 0 and Net Income < 0.
2. ROA (Return on Assets) – Measures how well all assets have been used and how well the equity and liabilities have been remunerated. It represents a measure of the return on investment, regardless of the source of financing (Liabilities or Owner’s Equity). The link between ROE and ROA is the Financial Leverage: where:
   • D is the Financial Debt
   • E is the Owner’s Equity
   • D/E is the Financial Leverage (Debt-to-Equity Ratio)
   • i is the Cost of Debt = Interest Expenses / Debt
   • t is the Tax Rate
   If ROA > i, (Operating profitability is higher than the Cost of Debt)
   • The company gets an economic return (ROE > 0) from its invested capital that is higher than the average cost paid for borrowed capital (i).
   • ROE increases relative to ROA as debt increases.
   There is therefore a Leverage Effect (which can act positively or negatively on the ROE) linked to the company’s debt. Shareholders' profitability could increase if the investment required for a new project were financed by a new debt costing less than the expected profitability of the project (ROA > i). Such use of leverage, however, would increase the risk to the owner of losing their investment. Financial Debt is risky because if the investment does not produce the desired results, and creditors are not paid in time, they could take legal action against the company and potentially lead to bankruptcy.
3. ROI (Return on Investment) – Measures the return on the invested capital. Investment Capital = Financial Debts + Owner’s Equity. Financial Debts = Current Debt + Long Term Debt.
4. ROS (Return on Sales) – Expresses the amount of operating income earned per euro of revenue. It only considers IS values, so it’s more reliable than ROI for assessing smaller companies’ profitability.

Turnover ratios

The Turnover Ratios are: Asset Turnover Ratio, PPE Turnover Ratio and Cash Conversion Ratio.

1. Asset Turnover – Represents a company’s ability to generate revenue from its assets. It indicates how much of the invested capital (total assets) return in the form of revenue.