Archive for the ‘Finance’ Category
Working Capital is the total of the amounts invested in current assets of the company. Net working capital results from the deduction of current liabilities from current assets; Working Capital Management consists of determining the volume and composition of sources and uses of working capital in such a way that would increase the wealth of stockholders. Working capital management is the management of current assets and current liabilities such that would result in the most desirable level of working capital and maximum company profitability. Inadequate working capital leads the company to bankruptcy. On the other hand, too much working capital results in wasting cash and ultimately the decrease in profitability.
Conventionally, it has been seen that if a company desires to take a greater risk for bigger profits and losses, it reduces the size of its working capital in relation to its sales. If it is interested in improving its liquidity, it increases the level of its working capital. However, this policy is likely to result in a reduction of the sales volume, therefore of profitability. Hence, a company should strike a balance between liquidity and profitability.
Refer to the ppt working-capital mgmt on Working Capital Management and how it affects Profitability.
A sales channel is about where you’re going to sell and how you’re going to sell. In fact, it is about where you’re consumer is willing to purchase your product, where the consumer expects the product to be available, what is the consumer decision making process regarding your category and product, and what is your positioning in the market. All the channel decisions should go hand in hand with Segmentation, Positioning, Pricing and other elements of the Mix.
For example, let us consider the purchase process of Toothbrush. Most consumers even today don’t know exactly which variant of the toothbrush they use, and many of them don’t really bother about the product much. The consumer may know that he uses an Oral-B (mother brand), but may not recollect the brand of the toothbrush. A consumer generally doesn’t remember a brand and ask for that particular brand at the retail store. Mostly the retailer displays or the consumer browses through the toothbrushes available and the consumer may recollect the brand, or the advertisement, or like the in-store promotions and product design for those toothbrushes and one of these elements of advertisement recall, product design, etc. may make the consumer consider and choose a particular toothbrush. So, in such categories, there is a lot of dependence on you’re presence in the store as the consumer remembers you only when you’re present in the store. There are lot of categories ranging from deodorants and refrigerators to laptops and anti-viruses. It depends a lot on your availability in the stores and consumers choose among what is available. So, channel becomes a crucial part of marketing strategy which is where to sell and how to sell. The channel and distribution management comprise the Place element in the Marketing Mix.
Under channel management, the company deals with external organizations(channel members or partners) to achieve its desired marketing goals and profitability. There are different types of channel partners like C&F Agents, Distributors, Retailers, OEMs, Value-Added Re-sellers (VARs), Brokers, etc. Each of the channel members business goals will differ in their expectations of profitability, sales, ROI, long-term prospects,etc. The right channel strategy will help bring coherence and build value to the customer, channel members and the company. So, a strong channel network has become a key component in corporate strategy.
As discussed, there are many factors that influence channel management, but following are the broad factors that influence a channel design or strategy:
1. Understanding of the Target Group, Target Segments, the consumer needs and the consumer behaviour
2. Understanding of the Marketing Mix and the product features, brand persona, positioning, pricing, etc.
3. Understanding of the retailers needs and behaviour
4. Channel goals and the functions to be performed by the channel
5. Legal Issues
6. Reach required
Refer IBM Route to Market Strategy for an understanding of how effective channel management helped IBM.
In many companies, financial, information and physical flows are often not synchronised. Managers take ecisions from an operational or financial point of view and do not recognise the impact of supply chain management on financial performance or vice versa. Growth, profitability and capital utilisation are better optimised through information, financial and physical supply chains integration. There is a strong interdependency. Operations and finance departments have to collaborate to reach common objectives.
Both operations and finance managers have to be bilingual and understand each other’s language. They must speak a common business language. The first step in developing this dual competency is a better understanding of how various concepts (in operations) and financial accounts are interrelated.
Better links between supply chain and finance The value of supply chain initiatives should be measured in terms of impact on cash flow and market value, and on key internal financial performance metrics such as economic profit (EVA), return on capital, return on equity, working capital, etc.
This objective can be reached by a three-step approach that provides a comprehensive vision of the existing relationship between companies’ operational and financial performance.
Understanding the answers to three key questions provides the basis for the approach.
1) How does operational performance impact the components of the financial statement (income statement and balance sheet)?
2) What is the impact of the operations in term of profitability, asset utilisation and financial leverage efficiency?
3) What is the impact of the operations on the ‘real’ pro!t that takes into account the cost of capital?
The financial impact of the supply chain components can be identified on the income statement and balance sheet. The income statement reflects the operating activities of the company during the year. It provides financial analysts and investors with key measures of profitability: revenue, expenses and net income.
This approach links the company strategy to the operational performance. If the company wants to increase its sales, or reduce its cost, it will act on different components of the supply chain. For example if the company’s strategic priority is to increase its market share and therefore its revenue, it will focus on leverage parameters such as perfect order fulfillment, order fulfillment cycle time, and so on.
In order to optimise the overall performance of the company, it is important to help establish the link between effective supply chain management and improved financial performance.
In the 1970s, Dutch economist Peter H. van Westendorp introduced a simple method to assess consumers’ price perception. It is based on the premise that there is a range of prices bounded bya maximum that a consumer is prepared to spend and a minimum below which credibility is indoubt. The Price Sensitivity Meter (sometimes called the Price Sensitivity Measurement) is based on respondents’ answers to four price-related questions.
A simple and easily executable method, the first step in the PSM is to ask respondents the following four price-related questions:
1. At what price do you begin to perceive the product as so expensive that you would not consider buying it? (Too expensive)
2. At what price do you begin to perceive the product as so inexpensive that you would feel that the quality cannot be very good? (Too inexpensive)
3. At what price do you perceive that the product is beginning to get expensive, so thatit is not out of the question, but you would have to give some thought to buying it?(Expensive)
4. At what price do you perceive the product to be a bargain – a great buy for the money? (Inexpensive)
From responses to these questions, cumulative frequency distributions are derived and plotted.
Interpretation of Results:
- The IPP generally reflects either the median price actually paidby consumers already in the market or the price of the product of a market leader.
- The range of prices between the PMC and PME is considered the range of acceptable prices. In markets that are already well established, few competitive products will be priced outside of this range.
- The OPP, according to this method, is the point at which the same number of respondents indicate that the price is too expensive as indicate that the price is too inexpensive. Manypricing researchers question whether this is the definitive optimal price for a product. The questions asked itself, force respondents to choose a range of prices (as opposed to just one) that they consider to be acceptable.
- Unlike discrete choice methods, the PSM does not replicate the actual shopping process. Instead, it tests respondents’ knowledge of a product’s price levels. The consequence of this reliance on consumer reference prices is twofold. First, results will vary depending on respondents’ experience with price levels in the market. If respondents do not have a good reference price, this method often causes the underestimation of a product’s ability to command a premium price. Second, results will vary as the market itself changes.
- Underlying the entire method is the concern that the questions directly ask respondents what they would be willing to pay for a product. Several researchers believe, however, that in order to be more effective, questions should focus on behavior rather than price. Additionally, these consumer-defined prices may not correspond with the actual range of acceptable product prices.
- Answers to questions used in the PSM do not reflect purchase intent.
Despite the concerns, the PSM remains a simple method; it is both easy to execute and easy to understand. Although we rarely propose its use and never recommend the PSM as a method for definitively selecting the price for a product, it can be used as a tool for gauging consumers’ price perceptions and expectations.
The last few years were a golden period for the FMCG industry. The economy was growing at a faster rate, imput prices were low, and inflation was low. This year the food inflation is very high around 12%, and the raw material cost has increased upto 15 to 20 percent compared to last year. The operating margins which are typically about 20 percent in the last few years have seen a drop to almost 16 percent.
High food inflation has an adverse affect on the FMCG industry. People will spend less money on discretionary items which will hit he FMCG industry. They say the fate of HUL is dependent on the monsoons. A good monsoon will not give any inflation worries and also increases the consumption power creating demand for hair oil, biscuits, soaps, shampoos, laundry, and toilet soaps.
High input costs
High input costs are another worry for existing woes. The cost of milk powder and sugar has gone up by 35 percent and 19 percent YOY and Nestle India is really struggling on its margins. The wheat used in ITC’s biscuits is up 10-15 percent thi year, the Copra used by Marico cost 10 percent more, the coconut and palm kernel oil used by Godrej Consumer has risen by 15-20 percent, and the menthol used by Emami has gone up by 20 percent. The heavy rains in Kerala might have caused the cost of Copra to increase and it doesn’t seem to be temporal. So, maintaining the margins this year is a tough task. Some of the FMCG players say that they will not increase the price of Low Unit Packs (LUPs) but may increase the prices of higher priced stock-keeping units (SKUs). The packaging cost which is very important in the FMCG sector has shot up by around 10 percent this year. They are expected to stay that way caused by the strong crude prices at $80 per barrel.
Rural Market is the way
Urban Markets are showing lower growth as compared to the rural hinterland. It is estimated that the big daddy Hindustan Unilever (HUL) gets almost 50 percent of their revenue from rural India , and Dabur gets almost 55 percent, and Marico gets 25 percent of their revenue from rural India. The Urban Markets are saturated with more and more competitors and less margins for the companies. For example, Toothpaste has a rural penetration of 40 percent as against 72 percent in the Urban areas. The underpenetrated categories such as toothpaste can be taken advantage of by companies like Colgate and HUL. Colgate started an initiative to educate people about the advantages of toothpaste and influence conversions from toothpowder and others. The volume growth in such categories will be fast.Shampoos showed a growth of 8.9 percent (Jan to May’10) compared with an urban volume growth of 2.5 percent.
The government schemes which have been launched over the past few years had helped in increasing the disposable income, in turn the purchasing power of rural India. Schemes such as Mahatma Gandhi National Rural Employment Guarantee Act (MGNREGA) which aim to put around Rs. 40,000 crores in the hands of the rural poor, leaves a large population with higher disposable incomes. This leads to some basic changes in the consumption patterns of greater consumption of personal care and above basic food requirements.
Balance Sheet of a Company:
A balance sheet gives the picture of assets and liabilities of the company as on the last minute of 31st March YYYY. So, many times the balance sheet of a company appears better than what it is in real. Sometimes, companies will request all debtors to clear the outstandings just to make a pretty picture by 31st of March. Every balance sheet must contain the previous year’s details too.
Let us first understand the various components in a Balance Sheet of a company.
a). Liabilities or Sources of Funds b). Assets or Application of Funds
Liabilities(H) or Sources of Funds(V)
The Profit at the bottom of the P&L Statement may be put into several Reserves, and will be shown in the Balance Sheet. Let us look into it.
1. Share Capital (Not at the Market Price but the historical price at which it is sold.)
2. Reserves and Surplus: It includes the following – The Reserves of the before year, if present. – The PAT component from the P&L Statement. NOTE: The Reserves and Share Capital come under liabilities because you are liable to pay to the shareholder.
3. Secured and Unsecured Loans
4. Current Liabilities (Dividend to be paid to the shareholders etc…)
Add all the above to form one leg of the Balance Sheet.
Assets(H) or Application of Funds(V)
1. Fixed Assets or Gross Block(historical cost only)
2. Depreciation: The fixed assets may depreciate in value, which is put here. But, the depreciation in Balance Sheet is accumulated every year for the machine, whereas in P&L it is only for that year. Suppose you bought a machine for Rs 5000/- and the depreciation is 10%. Then, in the first year it will show 500 in both P&L and the Balance Sheet, but in the second year P&L will show 500 and the Balance Sheet will show 1000.
NOTE: If Depreciation amount is less, it indicates that the company is fairly young and the due date for replacements is far. If the Depreciation amount is more in the Balance Sheet, it indicates that the company is decently old and the day for replacement is near.
Less: Depreciation (The depreciation should be minused from the Fixed Assets.)
3. Investments: Investments made by the company in other companys’ shares and others. Generally, companies invest in their suppliers companies to have a say in their company. Similarly, companies invest in the subsidiary companies.
4. Current Assets: This is opposite to Fixed Assets. Current Assets are those which will become cash in the near time. For example, semi-finished goods, Bank Balance is a good example of Current Assets. Sometimes, you give advances to your suppliers and these advances also come under Current Assets. Loans which generally include the loans given to the employees come under Current Assets.
Add all the above to form the other leg of the Balance Sheet.
The two legs of a Balance Sheet should be the same, and that is why it is called Balance Sheet because it always balances.
Profit and Loss Account Statement (P&L Statement):
1. Profit = Sales – Costs
2. So, you basically have two entities: Sales and Costs.
The other names used to refer to Sales are: Fees, Income, Sales, Revenue, and Turnover.
The other names used to refer to Costs are: Expenditure.
3. Classification of Costs or Expenditure
Capital Expenditure: Purchase of machinery, property or anything that goes for some period of permanence.
Revenue Expenditure: Expenditure for the day to day running of the business.
Direct Cost: Costs which are directly involved in the production of one’s products.
Indirect Cost: Costs involved in the support processes like adminstration etc…(Also called Overheads.)
Fixed Costs: Rent, Insurance, Salary and other costs which are pretty much fixed.
Variable Costs: overtime wages, petrol, stationery and other costs that are variable.
NOTE: Capital Expenditure will not be shown in P&L Statement because the costs invested are for long term expenses and you will enjoy the fruits for many years. A P&L statement is essentially for the current year, so you will not put it in the P&L Statement. But, this will be shown in the Cash Flows Statement, which will be explained in further blogs.
a. Indirect labor- fixed costs could be variable under certain circumstances
b. Indirect materials- variable costs
c. Insurance on building- fixed costs
d. Overtime premium pay- variable costs
e. Depreciation on building (straight-line)- fixed costs
f. Polishing compounds- variable costs
g. Depreciation on machinary (based on machine hours used)- variable costs
h. Employer’s payroll taxes- variable costs
i. Property taxes- fixed costs
j. Machine lubricants- variable costs
k. Employees’ hospital insurance (paid by employer)- fixed costs
l. Labor for machine repairs- variable costs
m. Vacation pay- variable costs
n. Patent amortization- fixed costs
o. Janitor’s wages- fixed costs
p. Rent- fixed costs
q. Small tools- variable costs
r. Plant manager’s salary- fixed costs
s. Factory electricity- fixed costs
t. Product inspector’s wages- fixed costs
4. Income or Sales is classified as:
Income or Operating Income or Sales Income: Income from the main line of business.
Other Income: Income from the dividends (dividends of the stocks bought by this company from other companies)
Income from sale of assets
For the sick mills of Mumbai, other income is much higher than the income, which indicates things are struggling.
So, let us see what a Profit and Loss Account is:
There are two sections in a Profit and Loss Account: Income and Expenditure (names may change as put above)
Sales/Operating Income: 4350
Other Income: 120
Total Income: 4470
Mfg Cost of Goods Sold: 2400
Gross Profit: 2070
Overheads (Distribution, Selling etc…) 1450
PBDIT (Profit before Depreciation, Interest and Tax): 620 (Also called the Bottom Line, because the costs below this cannot be controlled by the company.)
PBIT: 545 (Generally used to compare two companies.)
Profit before Tax (PBT): 425
Profit After Tax (PAT): 255 (6% of the original)
The Profit After Tax is going to be distributed into Reserves and the remaining amount will be carry forwarded to the Balance Sheet.
If your Gross Profit is huge, but your PAT is very less like above then it shows that the company is a TOP-HEAVY company.
If your Profitability is huge, then it is called CASH COW.
For better understanding you may refer to any companies profit and loss statement. Although you may see some extra components, the essence will be the same. For example, some companies may show Dividend Income seperately from Other Income and some of them may merge both and show as Other Income. Similarly, some may show the salaries seperately and some may not. But, the key points are the bolded ones above.
We will learn more about Balance Sheet in the next blog.
Limited Company : When we say XYZ Pvt Ltd or Public Ltd, what we mean by the word ‘limited’ in this context is the liability of the shareholders. It means, the liability of the shareholders, for the debts of the company, is limited to the extent of the share capital subscribed by them.
Let us suppose you are a shareholder of XYZ Pvt Ltd. In case if this company goes bankrupt tomorrow, then you will be liable only for your share capital. On the other hand, if this is not a Limited Company and if it is a Partnership. In such a case, if the company goes bankrupt, your assets may be taken into control to clear the debts made by the company, which essentially means you are Totally Liable.
Private Limited Company:
- Must have minimum two shareholders and max shareholders is 50
- Must have minimum two directors
- Cannot invite public to subscribe to its shares
- Transfer of shares is restricted to some conditions. The shares should be offered to present shareholders first and then to any outsider interested.
Public Limited Company:
- Must have minimum seven Shareholders
- Should have seven Directors
- Can invite public subscription of shares
- Permits free transfer of shares
All the above definitions and regulations are as followed in India