Financial reporting and Performance Measurement

PROBLEMA: OGNI AZIENDA HA INVENTARI DIVERSI

∈raw materials inventory work progress inventory finished p . invenotry∗365+ ∗365+ ∗36DIO= raw materials costs production costs( )productioncosts same % of completion

PROFITABILITY ANALYSIS

The profitability for shareholders is connected to the:

1. Operating profitability
2. Surplus assets profitability
3. Effects of financial choices
4. Effects of the non recurring items
5. (Effects of taxes)

The Income Statement shows the final operating result (profit/loss for the period).

Net profit shall be distributed to shareholders, who will then decide if this is satisfactory compared with costs.

(PROFITABILITY) = INCOME/ CAPITAL profitability for shareholders

TOTAL SHAREHOLDERS RETURN= deltaV+ dividend -deltaC ( contribution) market return

1. ROE = net earning / equity accounting return
2. ROE reported (after taxes) = net earning reported / equity ( net earning reported is the one that take into account non recurring items)
3. ROE

generate sales and I must control cost to earn a profit.

THE ROIC DEPEND ON:

• The relationship between operating sales and operating income (operating leverage effect);
• By operating costs (efficiency);
• From fixed investments (ASSETS);
• From operating Net Working Capital (working capital cycle)

QUINDI:

• An increase in sales increased the EBIT and so the ROIC
• A decrease in operating cost increased the EBIT and so the ROIC
• A decrease in assets (chef anno parte del NOIC) porta a un increase del ROIC perche il noic sta al denominatore
• If sales increase more than operating costs, then EBIT increases

The Operating Profitability of the company must be at least able to repay the cost of the source of financing (Debt and Risk), which have allowed the company to re-allocate this profitability

A virtuous company is the one for which the following relationship is true, in a continuous and tendential way, in the medium-long term:

ROIC* (1-t) >= Ke*(E/NOIC) + Kd*

percentage change in the EBIT over the percentage change in sales (how much the EBIT and so the operating income change over a given change of sales).

= CONTRIBUTION MARGIN/EBIT >1 (deve essere maggiore di uno, perche tutte le aziende hanno un po di fixed cost)

- Revenues

- Variable cost (operating)

= CONTRIBUTION MARGIN (contribution that additional revenues give to fixed cost)

- fixed costs (operating)

= EBIT

The more the cost are fixed the operating leverage will be more than proportional and so the EBIT.

The more the cost are variable the operating leverage will be lower

1 situation:

1. High fixed cost high operating leverage effects: se sales goes down, you loose much more money. If sales goes up, you earn much more money

2. High variable cost: low operating leverage effects: you loose less money if sales goes down

By comparing the two situations, in order to say which is the best one we have to say that it depends on the uncertainty of the volume of sales:

1. the higher is the volume of sales,

The lower is the uncertainty, the more I can take the risk of a high operating leverage degree (more fixed costs). In the case in which sales goes up you will earn much more money (higher EBIT), in the case in which sales goes down you will lose much more money.

The more the uncertainty, like if the market is very turbulent, there is high uncertainty about the volume of sales (economic crisis, competition), the more you are near the break even point, the more I have to be prudently oriented (it is better to have low fixed costs and more variable costs) and so a low operating leverage. In this way, if sales goes down you will lose less money, but if sales goes up you will earn less money.

1 GRAFICO

1. We can say that it is better to have a high leverage degree (1 grafico) because you earn much more operating profit.

2. If the market is very turbulent, there is high uncertainty about the volume of sales (economic crisis, competition), you lose a lot of money (1 grafico).

ASSETS PROFITABILITY

Surplus assets are

Those assets that are not essential for the operation of the business by a company. These may include property (like buildings), investments in public companies, excess cash and loans to other private companies.

Extra operational ROIC = RETURN ON SURPLUS ASSETS = extra operating income/surplus assets

ROA (RETURN ON ASSETS) = (EBIT + extra operating income) / (NOIC + surplus assets) (ROIC + RETURN ON SURPLUS ASSETS)

Quindi: With ROA we consider the effects on the profitability of capital due to the influence of operating and non-operating activities. The ROA therefore is an average between ROI and ROSA, weighted by the weight that each type of investment has on the total.

Financial leverage effects: When deciding whether to finance the company with debts or equity, I must consider that if I choose to finance with equity, the shareholders earn exactly the ROA (Return on Assets), while if I choose the latter case, the shareholders earn D/E * (kd).

D/E = 0. Dato che la net financial position è 0.

Allora anche i net financial expenses sono 0.

ROE= 100/1000 = 10%

The only investors are shareholders therefore they get all that the assets generate

ROA= ROE

We now move to another situation in order to analyze the effect of indebtness choice: (AZZURRO)

We make a different capital structure choice: We borrow money for 500 to repay the equity capital for shareholders so equity = 500 and NFP = 500. In this way the D/E ratio is 1.

We have also the cost of debt now that is 5% ( lo diamo per assunto, è un valore dato). In this way net financial cost are 25 (5% DI 500) and EBT(profit for shareholders) becomes 75. ( there is a decrease in profit for shareholder before taxes compared to the first scenario ).

ROE, ossia la profitability for shareholders becomes 15% (=75/500) ( so 10 % comes from the invested by shareholders + 5% comes from the financial leverage and so from the euros invested by others such as bank ) and so the profitability for shareholder increase (roe)

Ricapitolando: il profitto per gli azionisti diminuisce, ma la redditività per gli azionisti aumenta.

EFFETTO DELLEVA FINANZIARIA: in conclusione, la condizione per cui un aumento dell'indebitamento porta ad un aumento della redditività per gli azionisti è che il rendimento sugli asset (rendimento sul capitale investito) (ROA) sia maggiore del costo del debito (Kd). Se questa condizione è soddisfatta, più alto è l'indebitamento (D/E), più alto sarà il ROE.

Abbiamo una terza situazione: