Benefits, costs and income statement

Expenses x Costs Costs - financial accounting: Amount of money which the enterprise used to get benefits. - general economic view: The amount of money used to get higher utility, it includes opportunity costs. Costs ≠ Expenses Expenses - any decreases of the amount of money (cash or bank accounts)

Benefits x Revenues Benefits – amount of money, which the enterprise got for a given period aside from the payment of the money. Money equivalent of sold achievement of the enterprise. Revenues - any increase of the amount of money (cash or bank accounts) amounts received from customers for goods - amounts received from customers for goods or services delivered to them or services delivered to them Benefits ≠ Revenues

Economic result Economic result = Benefits – Costs If: Benefits > Costs → Profit Benefits < Costs → Loss

Income statement (profit and loss account) It shows business benefits compared with costs over a given time period (usually 1 year): a given time period (usually 1 year): Benefits X Costs Benefits X Costs.... ∑ Benefits ∑ Costs ∑ Benefits ∑ Costs Benefits > Costs → Profit (+) Costs < Benefits → Loss (-) ≠

What do you remember about costs? 1. Fixed costs (FC) - are not directly related to the level of production (include depreciation, rate, interests from loan …) - they change in one shot - total fixed costs are the sum of the individual fixed costs A) Short- term period:

2. Variable costs (VC) – change in direct relation to the volume of output they may include costs of sold goods or production expenses such as labor and power costs total variable costs (TVC) are the sum of the variable costs for the specified level of production or output average variable costs (AVC) are the variable costs per unit of output or of TVC divided by units of output B) Long-term period: In the long term period are all costs variable!!!

Categories of variable costs According to the level of output: a) same period → proportional costs, b) faster→ progressive costs, c) slowly → degressive costs.

Cost function Cost function: TC = FC + AVC * Q TC – total costs (proportional costs) FC – fixed costs AVC – average variable costs (variable cost/unit … AVC = VC/Q)

Costs description TC FC VC

Analysis of Break-Even point - it describes the relationship between: - profit, - costs, - volume of production, - price of production, - benefits. For the same type of production is the total revenue: TR = P * Q TR – total revenues P – price per unit Q – quantity of production (= sale)

Break-Even Analysis A break-even point defines when an investment will generate a positive return. A break-even point defines when an investment will generate a positive return. Break-even analysis is a useful tool to study the relationship between fixed costs, variable costs and returns. Break-even analysis is a useful tool to study the relationship between fixed costs, variable costs and returns.

Break-Even Analysis Break-even analysis computes the volume of production at a given price necessary to cover all costs. Break-even analysis computes the volume of production at a given price necessary to cover all costs. Break-even price analysis computes the price necessary at a given level of production to cover all costs. Break-even price analysis computes the price necessary at a given level of production to cover all costs.

Break-Even point Break-even point (critical point of profitability) – volume (quantity) of production Q BEP (Quantity of Break-Even Point), when total costs equals total revenues: TR = TC P * Q = FC + AVC * Q

Break-Even point - linear model -

Break-Even point - non-linear model - point of maximum profit

Enterprise´s objectives Some conceptions: 1)Maximalization of profit – total profit or some coefficient of the rentability (ROI, ROA) 2)Maximalization of market price of shares 3)Maximalization of value of the enterprise (MVA, EVA)

Value of corporation Present value of expected future net cash flow (profits) discounted to the present by the suitable discount rate. CF i – expected future cash flow t i – discount rate

Market Value Added Market Value Added = MVA Market Value Added (MVA) is the difference between the equity market valuation of a listed/quoted company and the sum of the adjusted book value of debt and equity invested in the company. The higher the Market Value Added (MVA), the better. The objectives of managers is a maximization of MVA. Disadvantage: It is possible to count it only for enterprises with marketable shares.

Economic Value Added Economic Value Added = EVA Difference between net profit of the enterprise and its costs of capital. EBIT – Earnings Before Interest and Tax T – profit tax rate (decimal number) C – long-term invested capital NOPAT – Net Operating Profit After Tax = profit after tax WACC – Weighted Average Costs of Capital (decimal number)

Economic Value Added EVA can be plus or minus number. The aim of business is to have plus results of economic value added, in this case the value of the firm increases. The enterprise should stop all the activities, which profit margin ration is lower than WACC. EVA shows that also own capital has to bring sufficient rate of return.

EBIT An advantage of EBIT - it is easier to calculate and easier to observe it at divisional or sub divisional levels of the firm. An advantage of EBIT - it is easier to calculate and easier to observe it at divisional or sub divisional levels of the firm. Instead of EBIT also the term Operating profit is widely used. Instead of EBIT also the term Operating profit is widely used.

WACC The cost of capital generally measured as weighted average cost of capital (WACC). The cost of capital generally measured as weighted average cost of capital (WACC). WACC is the cost of debt, such as interest on a loan, and the cost of equity investment, or rate of return. WACC is the cost of debt, such as interest on a loan, and the cost of equity investment, or rate of return.

Optimal capital structure = > rate of indebtedness Optimal capital structure of a company = searching of minimum of WACC – Weighted Average Costs on Capital

Average costs on capital WACC – weighted average costs on total capital (%) k i – costs on external capital before taxation of a profit (%) T – rate of profit´s taxation (decimal number) k e – costs on internal capital after taxation of a profit (%) B – market value of external capital in CZK V = B + S – total business capital in CZK S – market value of internal capital in CZK

Theory of U - curve Weighted Average Costs on Capital = WACC indebtedness (%) costs on capital (%) OPTIMUM costs on internal capital k e costs on external capital k i