small business management mgmt5601 workshop 3 part a ...€¦ · bootstrap financing versus debt...

© Mazzarol 2018 all rights reserved

Small Business Management MGMT5601

Workshop 3 Part A: Financial

Management

Professor Tim Mazzarol – UWA Business School

UWA Business School MBA Program [email protected] MGMTG5601

©Mazzarol 2018 all rights reserved


• Identify the main sources of

entrepreneurial capital.

• Understand key financial concepts.

• Know the difference between cash and

profit and common problems with

each.

• Assess your funding requirements.

• Understand the working capital cycle.

• Calculate break-even and review

financial statements.

• Apply key financial ratios.

• Address Action Learning Task 3

Workshop Overview


In this workshop we aim to:


Action Learning Tasks and Small

Business Diagnostic


ALT 3 – Financial Management

• Know financial accounting terms.

• Understand the importance of the working capital cycle within the small firm.

• Understand and calculate the Break-even point.

• Understand and apply the power of gross profit margin.

• Recognize the importance of pricing for profit.

• Review credit policy issues and relate these to cash flow management and profitability.

The ability to understand your firm’s financial performance, maintain

KPI to provide timely and accurate information for sustainable growth.


ALT 3/Financial Management &

Performance

How to monitor financial performance and gain control over the

business:

• Growth in annual sales turnover

• Premium pricing strategy

• Break-even analysis

• Gross profit margin analysis

• Gross & net profitability benchmarking

• Cash flow forecasting & monitoring

• KPI measures for financial performance

• Working capital management

• Long term debt management

• Independent company valuations

• Developing balance sheet strength

• Financial acumen of management team


How to match planning and performance via KPI benchmarking data:

• Regular analysis of business performance

against established plans.

• Monitoring variation levels in planned and

actual performance using KPI

benchmarks.

• Contingency planning for key suppliers to

ensure reliability of supply.

• Identifying key skills and competencies

needed to maintain competitiveness.

• Stock and inventory management and

control.

ALT 3/Internal Integration


How to obtain regular data on business trends and performance levels:

• Using performance and market KPI to

guide management decision making.

• Getting regular information on variations

between actual and planned performance

levels.

• Getting regular information on sales and

performance trends.

• Getting regular data on wastage rates.

• Benchmarking wastage rates against

known industry averages.

• Benchmarking employee absenteeism and

turnover against known industry averages.

ALT 3/Management Information


Video: sources of business financing


Sources of financing for small firms

Three sources of capital:

1. “Bootstrap”

- personal savings

- family & friends

- working capital

2. Debt

- bank loans

3. Equity

- private and public


Bootstrap financing versus debt financing

Bootstrap Financing

• Benefits of ‘bootstrap’ financing

– zero cost

– total control over the money

– no ‘application’ required

– no ‘minimum’ lending requirement

• Bootstrap ‘checklist’

– implement proven market ideas

– look for quick break-even

– look for high ‘gross profit’

– Sell directly

– Keep the team ‘lean’

– Control growth

– Focus on cash flow only

– Cultivate the banks early

Debt Financing

• Debt financing involves legally

enforceable agreement between

lender and borrower for:

– Repayment of principal and interest

– Usually secured against business or

other assets

• Legal risk of debt financing is higher

than equity

• BUT:

– Cost of debt capital is usually less

than outside equity

– Total capital raised is frequently

greater with equity

– Debt capital does not erode the

overall equity of the owner-manager

and any profits remain theirs


Bank financing

• Fast growing firms will soon need additional capital

• Banks supply most financing but need

– cash flow forecasts for business

– collateral in case of ‘failure’

• Entrepreneurs and Bankers

– have different viewpoints

• Entrepreneur ‘glass half full’

• Banker ‘glass half empty’

• A good business plan can assist bank financing


What are bankers seeking?

• Banks want long-term stable clients

• They look for:

– Good cash flow

– Adequate shareholder funds (working capital)

– Good reputation & standing

– Specific application of the funds

• The 5 C’s of bank lending:

– Character – good business track record

– Credit score – credit risk assessment

– Capacity – ability to repay the debt

– Capital – retain earnings/owner’s equity

– Collateral – assets that can secure loan


Video: what banks look for when lending


What to include in an application for bank

finance

• Personal Profile of Owner-Manager

• Information on the company– Product brochures

– Board Members

– Customer list

• Evidence of good credit rating

– Bank references

– Accountants & Lawyers

• Proof of company ownership or registration

– Audited accounts

• Financial Statements:– Balance Sheet

– Profit and Loss Account

– Cash flow Statement

• Future Earnings:– Budget for next year

– Order book

• Future Plans:– Business Plan

– Feasibility Assessments

• Security or Collateral


Average bank interest rates for small

business loans 2007-2014 selected countries

Source: OECD (2016)

Australia’s SME bank interest rates have been running at an average of 7.5%


Assessing your funding requirements

Net Fixed Assets

• Capital items

• Land

• Less: Depreciation

Net Working Assets

• Debtors

• Stock

• Work in progress

• Cash

• Less creditors

Equity

• Share capital

• Retained profits

• Goodwill

• IP Assets

Borrowings

• Loans

• Creditor strain

• Key elements for assessing the

funding requirements for a small

firm are:

– Net Fixed Assets (NFA)

• Fixed Assets less depreciation

– True Working Assets (TWA)

• Stock + Debtors – Creditors +

Creditor Strain (days payable)

– Equity (EQ)

• Share Capital + Retained

Profits

– External Funding Calculation:

• NFA + TWA – EQ

– Example:

TWA $70,000

NFA + $275,000

Less EQ ($120,000)

External funding need $225,000


The equity financing cycle

Firm at early stage

(e.g. R&D, proof of

concept)

VC funding required:

$50,000 to $500,000

Early Stage (e.g.

products defined

sales made)


$500,000 to $2m

Growth Stage (e.g.

product and market

expansion)


$2m to $10m

High Growth Stage

(e.g. IPO, M&A,

global markets)


$10m to $50m

Source: Barnett & Mazzarol 2002


Venture capital and late stage private equity

(VC&LSPE) sector in Australia

Source: ABS (2016)

Approx. 121 VC&LSPE managers and 210

VC&LSPE investment funds in Australia.

68% of VC funding is sourced locally.

42% of VC funding is from superannuation funds


Venture Capital investment process

Investment Proposal

OriginationVC Firm Specific Screen

Generic Screen

First Phase Evaluation

Second Phase

EvaluationClosing

Funded Project

Source: Fried & Hisrich (1994)

Reject Reject

Reject Reject

Reject Reject


Venture Capital screening

Source: Teten & Farmer (2010)


Pitching for venture financing

• Leave the shot gun at home– Ensure you know as much as possible about investor

before you walk in the door.

– Tailor your pitch to suit their investment track record.

– Seek to sell your deal to them as a compliment to their existing investment portfolio.

• Don’t sell your technology; focus on:– People – who’s who in the company?

– Product – what is the product & why is it good?

– Problem – what is the problem that this product is solving?

– Placement – where will the product be initially sold?

– Plan – how will all this work?

• Timing is everything – are you ready to go?

Source: Waston, 2003


Alternatives – P2P and Crowdfunding

Peer-to-Peer lending• P2P lending is still in an early stage and raised

around $25 million in Australia in 2015.

• Is debt not equity financing.

• Typically managed via online platforms

matching borrowers with lenders.

• Generally two main approaches, ‘auction’ or

‘posted prices’.

• ‘Auction’ model allows borrower to have more

control over the interest rate but final rate is

determined by the auction process.

• ‘Posted prices’ model uses an intermediary

(broker) to set interest rates and assess

borrower’s credit risk profile.

• P2P lending remains unregulated and yet to be

controlled by ASIC.

Source: Mazzarol and Reboud (2017)

Crowdfunding• Crowdfunding is also relatively new and can be

used for both equity and debt financing.

• Typically has four major forms:

1. Donation crowdfunding – money is donated

without anticipated returns (charitable).

2. Reward crowdfunding – funders get benefits

such as a product or service.

3. Debt crowdfunding – similar to P2P lending but

takes place on large scale e.g. retail P2P lending.

4. Equity crowdfunding – investors acquire share

capital in the firm and get dividends and capital

gains


Financial Management – the “Holy Trinity”

Balance Sheet

• Provides a cross-sectional snapshot of the firm’s net worth

• Assets – Liabilities = Owner’s Equity

Profit & Loss Statement

• Provides a picture of the firm’s past trading history

• Income – Expenses = Net Profit

Cash Flow Forecast

• Provides a forward estimate of the firm’s expected sales income & expenditures

• Debtors – Creditors = Net Income


Balance Sheet

Liabilities Equity Assets

• Comparing balance sheets over time shows the overall performance of the business.

• Balance sheet analysis allows the small business owner to make decisions about the overall strength of their firm.

• The Balance sheet shows the amount of cash and liquid assets available at that time and accounts receivable for future cash flow and working capital.

• Shows longer term assets that provide a foundation for future growth.

• Also shows the debt the firm has to pay within the financial year along with any longer term debt.

Is a “snapshot” in time of the firm’s value

Money

owed to

others

Net

Worth

Cash,

Receivables,

Stock,

Equipment &

Property

Source: Shultz (2006)


Balance Sheet - Assets

ASSETS:

• Current Assets (Cash & Cash Equivalents)

– Assets that are reasonably expected to be

consumed sold for cash, or transformed

into cash within the normal operating

cycle (i.e. the financial year).

– Identifies the firm’s working capital

(liquidity).

– Inventory should be as low as possible.

• Non-Current Assets

– Durable assets used in the operation of

the business.

• Accumulated Depreciation

– The aggregate of charges against

earnings to write off the cost of an asset

over its estimated useful life.

• Other Assets

– May consist of intangible such as patents,

prepaid expenses, surrender value of life

insurance.

Current Assets Current Liabilities

Cash $260,000 Accounts payable $350,000

Accounts receivable $580,000 Accrued expenses $190,000

Inventory $10,000 Income tax payable $10,000

Prepaid Expenses $120,000 Short term notes $50,000

Total Current Assets $970,000 Total Current

Liabilities

$600,000

Non-Current Assets Non-Current

Liabilities

Equipment, Furniture $50,000 Mortgages $100,000

Less: Depreciation ($20,000) Shareholders Equity

& Retained Earnings

$300,000

$30,000

Total Assets $1,000,000 Total Liabilities &

Equity

$1,000,000

Sources: Tarantino (2001) Shultz (2006)


Balance Sheet - Liabilities

Current Assets Current Liabilities

Cash $260,000 Accounts payable $350,000

Accounts receivable $580,000 Accrued expenses $190,000

Inventory $10,000 Income tax payable $10,000

Prepaid Expenses $120,000 Overdraft $50,000

Total Current Assets $970,000 Total Current

Liabilities

$600,000

Non-Current Assets Non-Current Liabilities

Equipment, Furniture $50,000 Mortgages $100,000

Less: Depreciation ($20,000) Shareholders Equity &

Retained Earnings

$300,000

$30,000

Total Assets $1,000,000 Total Liabilities &

Equity

$1,000,000

LIABILITIES:

• Current Liabilities

– Obligations that must be paid from current

assets during the normal operating cycle.

Usually includes monies to be paid to

creditors, expenses accrued from past

period, accumulated tax liabilities (e.g.

GST) and short term credit.

• Non-Current Liabilities

– Obligations such as mortgages that do not

have to be paid in the normal operating

cycle.

– Might also include director’s loans

• Shareholder Equity & Retained Earnings

– Shareholder equity can include common

and preferential stock.

– Retained Earnings is profits from past

trading periods not distributed to

shareholders.

• Total Liabilities and Equity

– Together these two items should equal

total assets.



Graphic display of the Balance Sheet

Current Assets, $900,000

Fixed Assets (less depreciation), $100,000

Current Liabilities, $600,000

Mortgages, $50,000

Equity & Retained Profits, $350,000

Assets Liabilities

Makes it easier to visualize the firm’s financial position and more accessible to all members of the team.


Dynamic Balance Sheet

Assets = Funding Need Liabilities = Funding Available

F

I

X

E

D

Net Fixed Assets:

Property, Plant & Equipment

Less Depreciation

Net Fixed Assets

$50,000

-$20,000

$30,000

Net Equity:

Share Capital & Retained Profits

Director’s Loans (provided by owner)

Intangibles (e.g. patents, goodwill at

purchase)

$300,000

V

A

R

I

A

B

L

E

Net Working Assets:

Inventory

Accounts Receivable (Debtors)

Prepaid Expense

Less Current liabilities:

Accounts Payable (Creditors)

Accrued Expenses

Income Tax Payable

Short Term Notes

Net Working Assets

$10,000

$580,000

$120,000

-$350,000

-$190,000

-$10,000

-$50,000

$110,000

Borrowings:

Creditor Strain (Accounts Payable Overdue)

Mortgages

Less Cash

Net Borrowings

$100,000

-$260,000

-$160,000

Assets = Funding Need $140,000 Liabilities = Funding Available $140,000

Shows total asset or funding needed against funding available within the business. Any short fall between assets

and liabilities is usually filled by creditor strain and/or director’s loans.


Profit and Loss Statement

Sales Revenue

Cost of Goods Sold

Gross Profit

Overhead Costs

Net Profit (EBIT)

Shows the firm’s performance over a given time period including sales revenues, both

variable and fixed costs and the amount of profit generated.

The P&L statement breaks down the income and expenses by major categories and can be

valuable to show how profitable a business is.

Regular monitoring of the P&L on a monthly or quarterly basis allows corrective action to

be taken.


Money paid

to the firm by

customers.

Variable

Costs e.g.

direct labour

and materials.

Profit from

sale of goods

or services

before

allocation of

overhead

costs.

Fixed costs

e.g. salaries,

rent & admin

expenses.

The “bottom

line” –

Earnings

Before

Interest & Tax


Fixed and Variable Costs

Fixed Costs

• Expenses that remain constant, regardless of operations (i.e. insurance, rates, salaries)

Variable Costs

• Expenses that vary in relation to output (i.e. cost of materials, cost of sales, casual labour)


Profit and Loss Statements – key elements

Profit & Loss Statement

Revenue $1,500,000

Less: Operating Expenses

(COGS)

$500,000

Gross Profit $1,000,000

Less Overhead Costs:

Administration & Salaries $500,000

Depreciation $20,000

Earnings Before Interest & Tax $480,000

Interest charges $20,000

Income Tax Payable $110,000

Net Income $350,000


The P&L Statement shows the performance of the business over a given time period

Gross profit margin = (Gross Profit x

100) ÷ Sales

Gross profit margin = 66.7%

Converting to % of sales provides ability

to compare trends:

Overheads = 33.3%

EBIT = 32%

Net Profit Margin = 23.3%


Cash Flow Statement

Accounts Receivable

Accounts Payable

Operating Cash Flow

Cash flow from other sources

Net Change in Cash Flow

Cash Flow Statement reports the sources and uses of cash during a specific

time period.

Usually examines cash flow from operations, investments and financing.

Forecasting cash flow is important to knowing how the business is performing.,

any variance between forecasts and actual cash flow requires urgent attention.


Money

owed to

firm by

debtors.

Money

owed by

firm to

creditors.

Cash

income

(+/-)

prepaid

expenses,

inventory

& tax

payable

Cash flow

from

investments

& financing

The

amount of

cash (+/-)

during the

period.


Cash Flow Statement – key elements

• Cash flow from operations– Includes net income from P&L, plus

changes in assets and liabilities.

– Accounts receivable is cash outflow as the money has not yet been received.

– Accounts payable is cash inflow because the money has not yet been paid so it held at bank.

• Cash flow from investments– Is cash outflow from the purchase of new

investments and inflow if sold.

• Cash flow from financing– Includes cash obtained from long or

short term loans, or the sale of any equity in the business.

– Any payment of debt or dividend payments to shareholders is recorded as an outflow.

• Change in cash bottom line shows if firm has had a positive or negative cash flow for the period.

Cash Flow Statement

Net income from P&L $350,000

Changes in Assets & Liabilities:

Accounts Receivable ($320,000)

Inventory ($5,000)

Prepaid Expenses ($10,000)

Accounts Payable $20,000

Income Tax Payable $2,000 ($313,000)

Operating Cash Flow before

depreciation $37,000

Depreciation $20,000

Cash flow from operations $57,000

Cash flow from investments ($10,000)

Cash flow from financing (mortgage) ($40,000)

Change in Cash $7,000 Sources: Tarantino (2001) Shultz (2006)

Cash Flow Statement shows how much cash is available plus sources and uses of cash

in the business


Cash flow forecasting


The Working Capital Cycle

CASHsales

receipts

suppliers raw

materials

work

in

progressfinished

goodssales

customers

(trade

debtors)

(trade

creditors)

costs

purchases

production

sellingand

distribution

costs

Source: Snaith and Walker, 1999


The financial operating cycle

Source: Sgambelluri (2010)

Working capital is essential to the

operation of the business.

Assets in the balance sheet are

used to create sales and are funded

by liabilities and “net worth” (e.g.

owners equity and retained profits.

The P&L statement shows sales

revenues, less cost of goods sold

(COGS) and overhead costs

resulting in a net profit or loss.

Any profits can then be distributed

by the owner in one of three ways:

1. To purchase more assets

2. To repay debt

3. To pay dividends to the owner


Improving small business cash flow

Tips for improving cash flow:

1. Get the payment upfront – 50% if possible.

2. Invoice same day you deliver the service or

the product.

3. Collect payment on time – chase payment

as soon as it is due.

4. Take advantage of credit or payment terms

from suppliers.

5. Keep you overheads flexible – outsource

tasks.

6. Manage inventory – don’t keep too much

stock.

7. Don’t be dependent on one or two

suppliers.


Causes of cash flow problems

Lack of sales

• Seasonal business trends or inadequate sales and marketing efforts

Not collecting the money owed

• Poor debtor control or slow to pay customers

Not negotiating adequate creditor terms

• Poor creditor control in relation to timing of debtor payment cycle

Holding too much stock

• Poor inventory management

Taking too much out of the business

• Funding lifestyle and failing to reinvest in the business for future growth

Buying too many fixed assets

• Money tied up in plant, equipment or property that might be better leased

Overtrading

• Trying to do too much too soon

Lack of Credit

• Upsetting the bank manager

Bad Management

• Not keeping cash flow forecast up to date

Source: DUBS (1995)


Causes of cash flow and profit problems

Cash Problems Checklist

Under capitalised?

Excess withdrawals?

Excess stock?Inadequate

debtor control?

Inadequate creditor terms

& control?

Excess fixed assets?

Bank problems?

Profit Problems Checklist

Turnover too low?

Profit margin (Prices) too

low?

Product costs &

contributions?

Departmental costs &

contributions?

Labour costs to high?

Material costs too high?

Overhead costs (e.g.

rent, salaries) too high?


Key financial indicators - Profitability

Ratio Formula Notes

Gross profit margin Gross profit margin = (Gross profit x 100) ÷ Sales A measure of the amount of money generated from sales

after variable costs are deducted.

One of the most important financial KPIs for a small firm.

Low gross profit margins indicate that it will take longer

for the firm to reach break-even.

Net profit margin Net profit margin = (EBIT x 100) ÷ Sales A measure of the firm’s overall profitability after fixed

costs are deducted.

EBIT = Earnings before interest and tax.

Rising net profit margins indicate that the firm has control

over overhead costs.

If it becomes necessary to reduce fixed costs the impact

on the firm can be significant.

Return on capital

employed (ROCE)

ROCE = (EBIT x 100) ÷ Total capital employed A measure of the value of the firm as an investment.

Use of the ROCE can help the owner-manager treat their

small business as an investment and compare its returns

to alternative investments.

Can be used to examine the efficiency of capital assets

held within the firm.



Power of Gross Profit Margin

Sales $ Gross Margin % Gross Margin $

1,000 10%

250 40%

333 30%

500 20%

800 12.5%



Sales $ Gross Margin % Gross Margin $

1,000 10% 100

250 40% 100

333 30% 100

500 20% 100

800 12.5% 100



Gross Margin $ Gross Margin % Sales $

100 5%

100 10%

100 20%

100 25%

100 30%

100 40%

100 50%



Gross Margin $ Gross Margin % Sales $

100 5% 2,000

100 10% 1,000

100 20% 500

100 25% 400

100 30% 333

100 40% 250

100 50% 200


Gross Profit Margin’s impact on pricing

Chart-A Existing % Gross Margin

5 10 15 20 25 30 35 40 50

% price reduction % volume increase for same gross profit

2.0 67 25 15 11 9 7 6 5 4

3.0 150 43 25 18 14 11 9 8 6

4.0 400 67 36 25 19 15 13 11 9

5.0 100 50 33 25 20 17 14 11

7.5 300 100 60 43 33 27 23 18

10.0 200 100 67 50 40 33 25

15.0 300 150 100 75 60 43

A higher Gross Margin allows more flexibility in pricing strategy


Key financial indicators - Liquidity

Ratio Formula Notes

Current ratio Current ratio = Current assets ÷ Current liabilities A measure of the current assets and liabilities in the firm.

Current assets = cash plus assets to be converted to

cash or consumed during years or operating cycle.

Current liabilities = liabilities that will be converted to

cash or consumed during year or operating cycle.

Ideal Current ratio = 1.5 to 2

If less than 1 the firm’s current liabilities are less than its

current assets and working capital is insufficient leading

to creditor strain (e.g. unable to pay suppliers).

Quick ratio Quick ratio = Quick assets ÷ Current liabilities A measure of the firm’s liquidity from a cash perspective.

Quick assets = cash and debtors.

Ideal Quick ratio = 0.7 to 1, but varies by industry.

Important to have a “debtor matrix” to monitor cash flow.

Defensive interval

ratio

Defensive interval ratio = Quick assets ÷ Daily operating

expenses

Estimate of how many days the business can run if no

more cash flows into it (e.g. 30, 60, 90, 120 days).

Not common but valuable if the firm is facing cash flow

problems.

Net working assets

ratio

Net working assets ratio = (Stock + Debtors – Creditors x

100) ÷ Sales

A measure of the overall working capital in the firm

needed to support sales activity.

It is useful to avoid “over trading” where the firm takes on

too much work and lacks adequate working capital to

fund the operations before accounts receivables are

settled.



Key financial indicators - Solvency

Ratio Formula Notes

Gearing Gearing = Total borrowing ÷ Total capital Gearing is the difference between the firm’s debt and the

total equity in its balance sheet.

Interest cover Interest cover = EBIT ÷ Interest Small firms facing financial losses will often experience a

rise in their level of gearing. Interest cover analysis helps

to identify this.

EBIT = Earnings before interest and tax.

Break-Even Sales Break-Even in $ = Fixed costs $ ÷ Gross margin % Break-Even is where the firm’s sales cover both its fixed

and variable costs. It is a measure of solvency because it

provides an indication as to what sales are needed to get

the firm’s profitability to a point where it can be solvent.

Gross margin % = Gross profit margin $ ÷ Total sales $

Margin of Safety Margin of safety in $ = Actual sales – Break-even sales

Or

Margin of safety % = Actual sales – BE sales x 100 ÷

Actual sales

A measure of the minimum sales turnover required each

month to achieve break-even.

Used in conjunction with the sales platform analysis it

can be a useful KPI for small firms seeking to remain

profitable and solvent.

It is important to know how many sales are needed on a

weekly, monthly or quarterly basis to ensure that the firm

achieves break-even.



Break-Even Graph


Four types of manager

S

B

SB

S

B

SB

The Busy Fool

Break-Even rises

along with sales

wiping out profits.

The Excellent Manager

Break-Even falls as

sales rise leading to

increasing profits.

The Good Manager

Break-Even falls as

Sales fall maintaining

profits.

The Bad Manager

Break-Even rises as

sales fall eroding

profits.


Key financial indicators – Efficiency

Ratio Formula Notes

Debtor turnover Debtor T/O ratio (debtors at % sales) = Debtors ÷ Sales A measure of how many times unpaid debt is turned over

within the business.

A rising debtor turnover ratio is an indicator that the firm

is taking too long to collect its debts with negative impact

on liquidity.

A falling debtor turnover is an indicator of efficiency in

recovering receivables.

Debtor collection

period

Debtor collection period = (365 x debtors) ÷ Sales A measure of the annualised collection period for number

of days to collect accounts receivable.

All firms should keep a debtor’s matrix to identify how

long each customer is taking to pay accounts receivable.

Normal collection should be within 30 days, and any

accounts that fall over 60 or 120 days are a concern.

Creditor turnover Creditor T/O ratio = Creditors ÷ Sales A measure of how long it is taking the firm to pay its

suppliers.

Rising trade creditor ratios are a sign of creditor strain

and usually signal the firm lacks working capital.

Creditor payment

period

Creditor payment period = (365 x creditors) ÷ Sales A measure of the annualised payment period for number

of days to clear accounts payable.

Monitoring debtor and creditor collection and payment

cycles will help the firm retain sufficient working capital

and avoid the need to increase debt and gearing.



Key financial indicators – Efficiency cont..

Ratio Formula Notes

Stock turnover Stock turnover ratio = Cost of sales ÷ Average stock at

cost

A measure of stock turnover and the efficiency of stock

carrying versus ordering costs.

High stock turnover ratios usually indicate efficiency in

managing inventory.

Average holding

period

Average holding period = (365 x Average stock at cost) ÷

Cost of sales

A measure of the relationship between the average stock

held within the business at cost, and the cost of sales.

Each type of business will have different dynamics and it

is important to set well-defined industry benchmarks.

It can be used to track product lines, or monitor the stock

turnover across different stores.

Creditor turnover Creditor T/O ratio = Creditors ÷ Sales A measure of how long it is taking the firm to pay its

suppliers.

Rising trade creditor ratios are a sign of creditor strain

and usually signal the firm lacks working capital.

Creditor payment

period

Creditor payment period = (365 x creditors) ÷ Sales A measure of the annualised payment period for number

of days to clear accounts payable.

Monitoring debtor and creditor collection and payment

cycles will help the firm retain sufficient working capital

and avoid the need to increase debt and gearing.



ALT 3 – Financial Management

Task Requirements:

• Review your firm’s liquidity level; do you

have sufficient working capital to support

your business activities?

• How does your balance sheet look and is

your business appropriately geared?

• How profitable is your business and do all

products make adequate gross profit

contributions?

• How efficient is your business and could

you improve your cash flows by better

debtor or creditor management and control

of stock or work in progress.

• Having reviewed your situation you should

develop some basic financial KPI for your

business and link these into your business

plan and operations control measures.

Key Documents

• ALT3 Financial management –introduction exercise

• ALT3 Financial management –action list

• ALT3 Financial management –financial diagnostic spreadsheet

End of Presentation