financial management 101

Financial Management 101• Source of Funds

• Sales Vs Profit

• Cashflow Management

• Debt Management

State Funded Regional Allocations

0

50

100

150

200

250

300

PacificM/way

SEQ SQ CQ NQ

2000-012001-022002-03

Sources of Main Roads Funding ($M)

261

19

3

8

21

19

834

Federal NationalH/waysFederal RoNI

1st Qtr

Federal Black Spot

Natural Disaster Relief

Private DevelopmentContributionsState Funds

Allocation of Main Roads Funding ($M)

522

313

65

52

118

95Construction

Rehab & Mtce

Regional P&P

Local Gov Subsidies

Corporate & TechnicalOutputsDebt Servicing

Sales vs. Profit Margin

The predominance of the Sales Paradigm

• Sales/turnover myopia

• The busy fool

Many think as follows:

• Sales = Income More is better

Gross margin

• Profit Margin = Income

Profit Margin is the only income of the business

Sales/Turnover

Sales are only a way of keeping score

Reference: Peter Knight, Hayes Knight Partners

Question: How many of you are stuck in the sales paradigm?

The power of the gross margin

Example Price decrease = 5%

Gross profit decrease = 50%Gross profit goes from $10 $5

•Consider effect of price decrease on number of sales

•Effect on cash

01020

30405060

708090

100

110120130

Gross Profit $10 Gross Profit $5

Val

ue

$ Gross Profit

COGS $90

Example Price increase = 5%Gross profit increase = 50%

The power of the gross margin

Gross profit goes from $10 $15

•Consider effect of price increase on number of sales

•Effect on Cash0

102030405060708090

100110120130

Gross Profit $10 Gross Profit $15

Val

ue

$ Gross Profit

COGS $90

Pricing

1) Profit =

2) Profit margin % =

3) Target revenue =

Revenue - COGS -Overheads

Profit margin

ProfitRevenue

Profit

PricingExercise 1: “The Sales Paradigm”

In 2000/2001 financial year a Business Unit of Commercial Operations had a turnover of $100M and achieved a profit margin of 2%. What is the dollar value of the profit achieved for the 2000/2001 financial year?

ANSWERANSWER

Profit = Revenue x Profit Margin

= $100,000,000 x 0.02

= $2,000,000

PricingExercise 1: (Cont)

Now let’s explore the effect of pricing on sales. You have been recently appointed to the position of Director - Asset Services (South) and currently you are preparing your budget for 2002/2003 financial year. As Director, you are required to contribute a net profit to the business of $2M. After discussions with the Regional Executive Directors for Southern and South East Region you believe that it would be possible to achieve a profit margin of between 2 – 5%. What level of revenue should you budget if you are able to achieve a profit margin of 2%, 2.5%, 3.0% and 5%?

Pricing ANSWERANSWER

We Know: Profit = Revenue - Expenses

Profit Margin = Profit Revenue

Therefore: Revenue = Profit

Profit Margin2% Profit Margin

Target Revenue = $2,000,000 = $ 100 M0.02

2.5% Profit Margin Target Revenue = $2,000,000 = $ 80 M



0.05

Pricing So What?So What?

• What can we do with this information? • What impact does this have on the Source of Funds from

the RIP?• Does more sales mean better?• What is the impact of Fixed costs of the business (eg Fixed

Labour Costs, Overhead Costs)?

Gross margin is the true income to the businessGross margin is the true income to the business

Exercise 2: “The effect of pricing on profit margin” In your notes is the MIS (Management Information System) report for RTCS Statewide. This report highlights a number of key financial indicators. Question:Review the “Winning Margin” financial indicator and determine the cash effect to the business if the actual “Winning Margin” was 2%. The term “Winning Margin” represents the percentage margin between the tendered price that won an open market job and the tendered price that came second. In other words it represents the percentage of money left on the table for an open market job.MIS Report states:Winning Margin: Actual is 5.9%, Budget is 6.3%Work Won: Actual is $45.2M, Budget is 47.7M

ANSWERANSWER Cash EffectMoney Left on the Table: @ 5.9% = $45.2M x 5.9%

= $2.66M (left on the table) @ 2% = $45.2 x 2.0%

= $0.9M (left on the table) @ 5.9% - 2% = $45.2M x 3.9%

= $1.76M

What does this represent in terms of revenue? Revenue Lost = Profit

Profit Margin

= $1.76M2.0%

= $88M

Pricing

• Total RoadTek Turnover for 2000/2001 was $280M • Lost Revenue of 31% of annual turnover

What does that mean? RoadTek could have priced only $192M of work and still achieved the samelevel profit.

The business cash cycle: Key themes The time, value of money Working capital – preventing bloat in

working capital: Debtors Creditors Time

How to achieve timely payment using: Invoicing Servicing delivery Reducing disputes

Value-adding management Reducing cash cycle times Focusing on tasks

Creditor management Creditor strain Settlement discounts

Cash

Stock equipment

MarginSales

Receivables

Cash: Managing cash

PositivPositive effect e effect on cashon cash

Above the line measures• Increase gross margin (do not discount)• Focus on value added per unit of time or

unit of space measures• Focus on reducing costs of goods sold to

increase price• Rationalise product range – drop low

margin products

Below the line measures

• Aim to reduce breakeven sales level by reducing overhead costs

Balance Sheet

Stock• Minimise amount and time held

Work in progress• Focus on job velocity• Shorter turnaround• Quicker invoicing

Debtors• Manage debtors• Stick to terms and enforce them• Recognise your benchmark

Creditors• Avoid creditor strain • Pay in a timely manner

Consider:

Sales Terms 30 days net

Cash cycle: Controlling cash

Sales during the month on credit

Customer pays

1 Sept

30 Sept

31 Oct30

days“30

days”

Calculating benchmarks: Debtors as a % of sales


Basis of calculations:

No. of days credit given x 100

No. of days in one year

Eg. 60 days credit given:

60 X 100 = 16.4% say 16%

365

Credit given Benchmark7 days 2%14 days 4%30 days 8%45 days 12%60 days 16%75 days 21%90 days 25%

105 days 29%120 days 33%



Exercise 3: “Debtors as a % of sales”

As at 31 December 2001 the RTCS Business Group reported Accounts

Receivables of $25.1M with an estimated annual turnover of $280M.

What is the % Sales in Debtors and is this result reasonable?

% Sales in Debtors = Accounts Receivables

Annual Sales



ANSWERANSWER % Sales in Debtors = Accounts Receivables

Annual Sales

= $25.1$280

= 9.0%

This represents average days of credit given of 33 days.

Debt Recovery

Exercise 3: “Debt Recovery”

You have a bad debt of $10,000 and have exhausted all options of recovering the debt and the debt is written off.

What amount of additional revenue must be generated to break even and recover this loss.

Assume your profit margin is 2%.


Debt Recovery

ANSWERANSWER

Revenue = Profit

Profit Margin

= $10,000

0.02

= $500,000


1) Buying/investing in stock “just-in-time”

Making a start

Check your stock level (raw materials) against the benchmark data

Establish where you are now and work on it (use the measure as a guide to progress)

Suggestions:

• Consider free in to store system, i.e. suppliers keep you stocked and charge only what you use

• Carefully consider bulk buying discounts – calculate the true cost using a discount rate formula e.g. value of stock + interest paid on funds under to purchase and hold for the period (N.B. use your overdraft interest rate)

• Consider implementing “just-in-time” system with a dedicate supplier for major inputs

Shortening the cash cycle


Shortening the cash cycle


2) Focus on job velocity

Making a start Identify main products or services Follow each through the various value-adding processes in the business Map out the process and record times taken and delays Measure value-adding time and measure non value-adding time. Establish

the value-adding ratio (value-adding time/none value adding time) Use this information to achieve a better result

Suggestions• Involve staff in key areas in identifying product/service process flows• Identify areas of delay and concentrate on the largest first• Use measures such as value-adding ratio and time taken, as a guide• Consider sub-contracting if you are inefficient in areas

Shortening the cash cycle3) Invoicing effectively

Making a start Balance efficiency with effectiveness, i.e. invoice to get paid as soon as possible

(efficiency may dictate invoicing in bulk at month’s end – is this effective?). Recognise the “Gratitude Concept”

Suggestions• Invoice when tangible value is delivered• Plan jobs with invoicing points in mind, based on identifying gratitude points

Gratitude

Time

Job completion/value delivered

Invoice here for quick payment


Shortening the cash cycle4) Receivables and terms of tradeMaking a start

Review your debtors against benchmark Review your terms of trade and performance If performance is below benchmark? Look at:

• Debtor awareness• Invoicing – Timing of invoices• Debtor follow-up/terms enforcement

Develop a debtors management system Document procedures and train staff

Suggestions• Review current procedures• Develop strict procedures for querying all accounts outside your terms• Stick to your terms and enforce where required• Review job commencement procedures to ensure terms are explained and given

importance• Monitor receivables systematically (at least weekly)


Cash cycle: Key principles summarised

Bloat or blow out in working capital is caused by: Too much stock

• Raw materials• Finished goods• Billable hours

Debtors too high Poor creditor management Poor cash management



How to shorten the cash cycle:

1. Buy/invest in stock “just-in-time”2. Focus on job velocity, i.e. shorten the value-adding time3. Invoice on completion or at key points on the gratitude curve4. Focus on receivables and terms of trade5. Always consider the time value of money



DepreciationDepreciation

Fixed Assets are Resources

Their Earning Capacity Reduces over use and time

Depreciation is a measure in the reduction in capacity of the assets

No reduction in cash

Reduction in asset worth

What Happens to the WealthDividends Return to the Owner Reduces Net worth / Equity Reduces Resources (CASH)

OR Reinvest No Change to Net Worth No Reduction of Resources Resources are Available to Build the Business

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