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Business management analysis using financial statements: Example

Business management analysis using financial statements: Example


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Management Analysis - Example of Fan Company UD1

Table 1 PROVISIONAL EXPENDITURE - EARNINGS SCHEME (DATIAZIENDALI)

EARNINGS

wheat sales

L. 22.500.000

venditagirasole

L. 27.000.000

work for third parties

L. 450.000

interessiattivi

L. 719.000

venditarimorchio

L. 800.000

TOTALEGUADAGNI

L. 51.469.000

EXPENSES

acquistofertilizzante

L. 1,300,000

sunflower seed

L. 3,000,000

herbicide

L. 1,380,000

lubricating fuels

L. 1.000.000

riparazioneseminatrice

L. 300.000

overheads

L. 570.000

mortgage payment

L. 5.861.372

passive interests

L. 650.000

social charges

L. 1,300,000

taxes

L. 2,500,000

acquistorimorchio

L. 3,500,000

noleggipassivi

L. 2,700,000

TOTALESPESE

L. 24.061.372

GUADAGNONETTO

L. 27.407.628


At this point, however, to be sure that he has done the math correctly, he decides to ask Angelo, his trusted technician, for an opinion. This remained marvelous by the order in which the management events were noted and is happy to help the entrepreneur, but he immediately explains that the data organized in this way is not sufficient to express the economic result of the management, but it is necessary to make some corrections and additions.

In the first place Angelo points out that two errors were made in the scheme:

  • the loan installment is made up of a principal portion and a portion of interest, and only the latter are influential for the purpose of determining corporate income. It is therefore incorrect to include the entire amount of the installment in the company's expenses, as Mr. Ventola had done,

  • the purchase and sale of capital goods, in the same way, cannot constitute earnings or expenses for the company, referable to the year; in fact, the trailer purchased will be used for a much longer period of the year and therefore only part of its value represents a cost for the year in question (depreciation). Even the sale of second-hand products cannot be a profit, since it is a change in the balance sheet; any gain or loss (capital gain or loss) is recorded when a well-depreciable item is sold for an amount other than the net value (historical cost less depreciation).

From all this Angelo points out that it is necessary to have further information and Mr. Ventola is happy to collaborate to provide it. The additional elements that result from the joint commitment of Angelo and Signor Ventola are:

  • the medium-term loan referred to was paid for an amount of £ 35,000,000 in 1991, at a subsidized interest rate of 7% per annum, and to be repaid in 8 years, starting in 1992, with constant postponed annual installments . This is practically the second installment that is paid. With these data, by calculating the mortgage amortization plan, it is possible to separate the share capital from the interest portion for each installment, until the mortgage is completely extinguished; for the second installment, the one paid on 31/8/93 is a capital share of £ 3,650,168 and an interest of £ 2,211,204. at this point a high problem arises: since the reference period of the installment paid in 1993 goes from 8/31/92 to 8/31/93, only a part of the interest paid with the second installment belongs to 1993, and precisely that which goes from 1/1/93 to 31/8/93, while the remaining part is 1992's jurisdiction; on the other hand, for the period from 31/8/93 to 31/12/93, part of the interest relating to the third installment must be charged. The interest on the mutual competence of 1993 will therefore amount to £ 2,126,033, as shown by the Table 2;

Table 2 DETERMINATION OF PASSIVE INTERESTS FOR THE PERIOD

Annual interest

Monthly interest

Interest period

Interesting passages 1/1 - 31/8

2.211.204

184.267

1.474.136

Interesting passives 31/8 - 31/12

1.955.692

162.974

651.897

Total interest expense

2.126.033

  • it is incorrect to include the amount of sales of multi-year goods such as trailers as positive income components as they constitute a change in assets; any capital gain (homo-capital gain) resulting from it increases (or decreases) the value of the Net Capital. Considering the use of the asset and the time elapsed since its purchase, a value of £ 1,000,000 can be attributed to the used trailer. However, the supplier did not pay this amount in consideration of the expensive repair he had to carry out on the trailer itself. A loss of £ 200,000 (£ 1,000,000 - £ 800,000) has therefore arisen in this situation;

  • on the other hand, it is not even correct to insert the negative amount of the entire purchase of the trailer into the negative income components, since, even if it had been paid in full by the year 1993, it is an equipment that will be used for several years (for example 8), and therefore its cost must be divided into 8 parts to be attributed each to a specific year (Table3);

Table 3 DETERMINATION OF TRAILER AMORTIZATION

Description

Purchase year

Purchase value

Duration (years)

Annual depreciation

Trailer

1993

3.500.000

8

437.500

  • the same problem occurs for all the other machines and / or equipment, and for the real estate that the farm owns, even if not purchased during the year. Even in this case, although there is no money issue, the very fact that the capital goods are used, and which decrease their value, determines the calculation of their depreciation, which constitutes a cost for the company distributed in each year of life of the well. Angelo then asks Signor Ventola to fill in a times table similar to Tabella4, by entering the data of all the other company machines and equipment, in order to correctly determine the depreciation value.

Table 4 DEPRECIATION OF DEPRECIATION OF CORPORATE INVESTMENTS

Description

Purchase year

Purchase value

Duration (years)

Annual depreciation

Trattrice

1991

40.000.000

10

4.000.000

Drills

1985

2.200.000

10

220.000

Plow

1980

600.000

15

40.000

Harrow

1985

1.800.000

15

120.000

Fertilizer

1987

900.000

10

90.000

Weeding barrel

1985

700.000

10

70.000

warehouse

1978

25.000.000

20

1.250.000

Tool shed

1978

16.500.000

20

825.000


Angelo also asks Mr. Ventola what destination the 50 quintals of wheat had that were not sold during the year. The answer is that, for a small part (5 q) they were used for the breeding of poultry (intended only for family consumption), a part (25 q) was selected, spending £ 500,000, to be used as a seed for l the following year, while 20 q are still in the Ventola company warehouse.
Another required information refers to how many expenses had already been incurred the previous year for the wheat crop harvested during 1993, in particular for sowing, autumn fertilization, etc. The agricultural entrepreneur estimates a sum of approximately £ 2,300,000 . On the other hand, it is also important to know the amount of expenses incurred for the cultivation of wheat that will be harvested in 1994. In this case, the selected production has been used for seeds, with an additional cost of £ 500,000, in addition to the value of 25 quintals wheat, which can be estimated at around £ 750,000; other expenses incurred for the following year's total amount to £ 450,000.
At this point the technician and the agricultural entrepreneur, by mutual agreement, draw up a new Expense - Earnings scheme (Tabella5), which correctly indicates the amount of the net credit obtained from the activity for the farm. This statement is not that the Income Statement in which it is immediately noted that the Net Profit (Net Income) has decreased by over £ 1,150,000, after having taken into account all the elements that must be correctly included among the economic components.

Table 5 DEFINITIVE EXPENDITURE - EARNINGS SCHEME (INCOME STATEMENT)

EARNINGS

wheat sales

L. 719.000

consumption

final crop advances

Closing inventory

L. 150.000

L. 1,700,000

L. 600.000

TOTALEGUADAGNI

L. 53.119.000

EXPENSES

acquistofertilizzante

L. 2,126,033

passive interest cond.

L. 2,500,000

passive rentals

trailer depreciation

other depreciation

initial crop advances

L. 2,700,000

L. 437.500

L. 6.615.000

L. 2,300,000

TOTALESPESE

L. 26.178.533

GUADAGNONETTO

L. 26.940.467


Angelo explains that with very little additional work, much more information can be obtained on the company's management performance. Intrigued, Mr. Ventola asks him to explain himself a little better, and declares his availability. Angelo then talks to him about the reclassification of the Income Statement, and this is a method that, starting from the scheme they have obtained, through an exposure of expenses and earnings, highlights important components for management, such as Gross Salable Production, Added Value, Product Net and Operating Income. Through this new scheme, firstly it will be possible to make a subdivision between agricultural activity in the strict sense and the other commitments that flow around it (financial, ancillary, extraordinary management, etc.).
Following the application of the reclassification, the schematic produced by Angelo and Mr. Ventola is configured in the manner envisaged in Tabella6; the values ​​are expressed in thousands of lire to make the results easier to read. The technician points out to the farmer some important indications that arise from the table obtained:

  • the value of the salable production (PLV) was almost 49 million;

  • typically agricultural activities generated an (operating) income of just over 30 million;

  • overall, the company produced a (net) income of just over 26 million.

Table 6 THE RECLASSIFIED INCOME STATEMENT

Sales revenues

self-consumption

final crop advances

Closing inventory

initial crop advances (-)

49.500

150

1.700

600

2.300

Gross production

49.650

raw material

passive rentals

maintenance and repairs

overheads

6.680

2.700

300

570

VALUE ADDED

39.400

depreciation

7.052

NET PRODUCT

32.348

social charges

1.300

OPERATING INCOME

31.048

passive interests (-)

active interests

taxes (-)

subcontracting

2.776

719

2.500

450

NET INCOME

26.940


Angelo explains that these are only the first results; to express the assessments, other information is also required that also involves the company's assets, as it is very different to produce 100 having invested 1,000, or investing 10,000.
They then decide to say goodbye and to postpone the discussion for a future meeting with the agreement that in the meantime Mr. Ventola prepares a summary of the structure of the company at the end of the year 1993, a kind of photograph of what is present in the company, indicating separately the value of land and agricultural capital, the presence of short and medium / long-term credits and debts, the availability of cash in the bank and in cash. Ventolarimane a little perplexed especially for the last request, but nods and greets him cordially.
A few days after the meeting with the technician, Mr. Ventola sits at the table to reflect on what has been discussed and decides to prepare a table on the structure of his company, to then submit it to Angelo for any corrections and / or additions.

Let's see what are the highlights of Mr. Vent's analysis.

  • The machines and equipment present in the company have already been recognized previously for the calculation of depreciation (Table3 is Table 4).

  • The same goes for the buildings (warehouse and tool shed) always detected Table 4.

  • The cultivating land, equal to about 35 ha, was purchased in part (15 ha) in 1978, together with the farmhouse, paying a sum of £ 90,000,000; subsequently, in 1985 the company area expanded with the purchase of another 20 ha, for an amount of £ 101.5 million.

  • At the end of the year, the company does not have any credit to its customers, while it still has to pay half of the combine harvester account (£ 1,350,000), and part of the expenses incurred during the year for £ 3,700,000.

  • In the company there is a medium-term loan, taken out for £ 35,000,000 and added to the third year of repayment. Mortgage data has already been submitted.

  • The balance of the bank account at the end of the year is £ 13,000,000, while the cash balance is £ 700,000.

At this point, Mr. Ventola tries to summarize the salient points shown above through a scheme, in which on the one hand he inserts the assets of his company, and on the other the debts and mortgages that he has assumed (Tabella7). Again, he makes an appointment with Angelo to correct any errors with him and make additions, so as to constitute a complete picture of the company's equity and financial situation. Even this time Mr. Ventola has committed some inaccuracies and has not taken into account all the fundamental elements for the determination of the company's equity and financial situation.
Let's see what comments Angelo makes to Mr. Ventola.

  • Firstly, the value of machinery, equipment and buildings that must be taken into account is a value net of depreciation that has already been set aside. The techniques to be adopted could be two: either the value of the asset is left at the time of its purchase and the related depreciation funds for the total depreciated value are entered in the opposite section, or the value of the capital goods is entered, already reduced by that of the depreciation. We opt for this second street. The depreciation accrued up to the present moment is therefore calculated for each asset, as shown by the Tabella8.

Table 7 PROVISIONAL BALANCE SHEET DIAGRAM

GOODS

Machinery (tractor)

L. 40.000.000

equipment

L. 6,200,000

Buildings

L. 41.500.000

plots

L. 150.000.000

Bank c / c

L. 13.000.000

Cash desk

L. 700.000

TOTAL

L. 251.400.000

DEBTS

Providers

L. 5,050,000

Mutual

L. 23.277.257

TOTAL

L. 28.327.257


Table 8 DETERMINATION OF RESIDUAL VALUE OF COMPANY INVESTMENTS

Description

Anniammort.

Valoreacquisto

Annual depreciation

Total depreciation

Residual value

Trattrice

3

40.000

4.000

12.000

28.000

Drills

9

2.200

220

1.980

220

Plow

14

600

40

560

40

Harrow

9

1.800

120

1.080

720

Fertilizer

7

900

90

630

270

Weeding barrel

9

700

70

630

70

Trailer

1

3.500

438

438

3.063

warehouse

16

25.000

1.250

20.000

5.000

Rimessaattrezzi

16

16.500

825

13.200

3.300

TOTALMachines (Tractor)

4.000

12.000

28.000

TOTALEAttrezzature

978

5.318

4.383

TOTALEFabbricati

2.075

33.200

8.300

  • In calculating the residual value of the mortgage, Mr. Ventola deducted the total amount of the two installments paid from the initial loan; in reality the correct procedure is to subtract only the part of the capital paid in each installment. from Table 9, which sets out the mortgage amortization plan, it should be noted that as of 31/12/93 the residual amount is equal to £ 27,938,460.

Table 9 CALCULATION OF THE LOAN DEPRECIATION PLAN

Deadline

Ratan °

Total installment

Interest

Depreciation fee

Residual debt

31/8

1992

1

5.861.372

2.450.000

3.411.372

31.588.628

31/8

1993

2

5.861.372

2.211.204

3.650.168

27.938.461

31/8

1994

3

5.861.372

1.955.692

3.905.679

24.032.781

31/8

1995

4

5.861.372

1.682.295

4.179.077

19.853.704

31/8

1996

5

5.861.372

1.389.759

4.471.612

15.382.092

31/8

1997

6

5.861.372

1.076.746

4.784.625

10.597.466

31/8

1998

7

5.861.372

741.823

5.119.549

5.477.917

31/8

1999

8

5.861.372

383.454

5.477.917

0

  • Other elements that must be considered in the determination of the company's equity and financial situation are the inventories and the final cultural advances, which must be included as active components of the company.

  • The entrepreneur uses a single current account for family and business management; in this case, it is appropriate to separate the financial movements deriving from the business activities from those related to family life by reading the statement; in the future it is advisable to open an account dedicated exclusively to the company if you want to maintain clarity in financial management.

  • A final consideration must refer to the way in which the interest expense on the mortgage for the Expense - Earnings scheme was counted. It should be remembered that part of the interest relating to the third installment (sum of £ 651,897) was charged, which will be paid only in August 1994. In this situation, a passive installment arises, which finds its place in the liabilities of the Balance Sheet.

At this point, to complete the scheme, it is necessary to calculate the entrepreneur's financial resources invested in the company (equity or net capital), making it the difference between the total assets invested and the debts assumed. Angelo redigenovamente the scheme that appears as shown in Tabella10. The first impression obtained is related to the strong presence of real estate financed almost exclusively with equity.
Angelo informs Mr. Ventola that he will be able to provide him with further information on his financial and asset situation only after proceeding with the classification of the Balance Sheet (this is the name of the prospectus they have elaborated). In this case, too, it is a question of restating the assets and liabilities items on the basis of the growing liquidity criterion, that is, on the possibility of converting the various components of the financial statements into liquid money. As also in the reclassification of the Income Statement, even now the values ​​can be expressed in thousands of lire to facilitate the reading of the figures. It is immediately evident how the company is strongly capitalized (land capital represents the largest share of corporate loans), especially for the value of the land, which alone exceeds the sum of all other investments. On the sources side, it is confirmed that the company has been financed mainly with the entrepreneur's own resources and with a modest share of medium and long-term debt (mortgages).

Table 10 DEFINITIVE BALANCE SHEET

ACTIVE

Cars

28.000.000

equipment

4.382.500

Buildings

8.300.000

plots

150.000.000

Bank c / c

13.000.000

Final cultural advances

1.700.000

Closing inventory

600.000

Cash desk

700.000

TOTAL

206.682.500

PASSIVE

Debitiv / suppliers

5.050.000

Mutual

27.938.461

Capitaleproprio

146.101.675

Helpful

26.940.467

Passive rate

651.897

TOTAL

206.682.500


At this point Angelo says that there are almost all the basic elements to be able to conduct a more in-depth analysis of the company, both from an income point of view (reclassified income statement), and financial and balance sheet (reclassified balance sheet) (Tabella11).
To do this, it is preferable to express the results thus classified in percentage value, comparing them perhaps with those of other similar companies. Angelo then said goodbye to the entrepreneur, promising him that some day he would return with summary results on the company management.

Table 11 RECLASSIFIED BALANCE SHEET

FINANCIAL USE

206.683

CAPITALEFONDIARIO

158.300

plots

150.000

Rural buildings

8.300

CAPITALEAGRARIO

34.683

Cars

28.000

equipment

4.383

Closing inventory

600

Final cultural advances

1.700

LIQUIDITADIFFERITE

-

Credits

-

LIQUIDITAIMMEDIATE

13.700

Bank c / c

13.000

Cash desk

700

FINANCING SOURCES

206.683

PASSIVITACORRENTI

5.702

Providers

5.050

Accrued liabilities

652

PASSIVITACONSOLIDATE

27.938

Mortgages

27.938

OWN MEANS

173.042

Net capital

146.102

Profit from exercise

26.940


Through the analysis by components of both the Income Statement and the Balance Sheet, it is possible to obtain a first image of the company management in relative terms, that is, regardless of the company size and inflation processes. In this way it is possible to compare both the data of several years and of several companies. In this case Angelo relates the results (ContoEconomico) of the Ventola company with an average calculated between several homogeneous companies of which he keeps the accounts (Tabella12).

Table 12 COMPONENTS OF THE RECLASSIFIED INCOME STATEMENT

COMPONENTS

Fan

Average

Sales revenues

99,7%

91,4%

self-consumption

0,3%

0,6%

final cultural advances

3,4%

3,7%

Closing inventory

1,2%

7,0%

initial cultural advances (-)

4,6%

2,8%

SALESTABLE PRODUCTION

100,0%

100,0%

raw material

13,5%

12,2%

noleggipassivi

5,4%

1,0%

repairs and repairs

0,6%

0,6%

overheads

1,1%

2,5%

VALUE ADDED

79,4%

83,7%

depreciation

14,2%

22,6%

PRODOTTONETTO

65,2%

61,1%

social charges

2,6%

6,7%

OPERATING INCOME

62,5%

54,4%

passive interests (-)

5,6%

7,1%

interessiattivi

1,4%

1,5%

taxes (-)

5,0%

2,9%

subcontracting

0,9%

3,5%

NET INCOME

54,3%

49,3%


Starting from the economic aspects in the Ventola company, there is a greater incidence of variable costs than the average, above all in the component of passive rentals, which weigh more than 5% of the PLV. On the other hand, it is noted that the incidence of depreciation is significantly lower than the average. This may indicate that Mr. Ventola's corporate policy has turned to less internal mechanization of the company, more often resorting to passive rentals.
Another interesting element is the lower percentage of labor costs. Since these are companies where almost exclusively family labor is used, the different incidence is presumably attributable to social security contributions, which change according to the number of UL.
The last considerations refer to the enacted operating profitability. Both are better in the Ventola company; even 62% of PLVriesce to turn into operating income, against an average of almost 55%. The positive margin between the result of the company and the average one decreases slightly passing to the net profitability, due to a greater negative impact of the extra-characteristic management. In any case, the fact that over 53% of the PLV becomes a profit, compared to an average of 49%, can only be considered positively.
The analysis by balance sheet components (Tabella13) presents a first image of the capital and financial structure from which it appears that Mr. Ventola owns a rather solid company, in which there is little recourse to external financing, while most of the investments have been financed over the years by the entrepreneur's net capital, and the reinvestment of any accrued profits. The ratio of equity to total funding sources is higher than 83% (around 10 percentage points above the average) while, with regard to the use of external financing, the company seems to favor medium-long term debt rather than soon. Overall, however, there is a lower incidence of debt, even if this is not necessarily a symptom of company health.
On the active component side, the most consistent component is represented by the land capital, and in particular by the value of the land, which, unlike machines, buildings and plants, does not suffer a loss in value over the years (depreciation), but rather increases it. As regards the agricultural capital, the Ventola company is considerably below the average, above all because of a low value of machines and equipment, determined not only by numerical inferiority, but also by aging.
The considerations presented through the analysis by components of the income statement and balance sheet will be subsequently taken up and analyzed in depth in the analysis of the indices. Since, however, an accurate analysis cannot disregard the technical characteristics of the company, it is interesting to integrate two reclassified schemes with other quantitative information, relative to the UAA, to the power of the company machines, in addition to the overall working hours used: all data that surely Mr. Fan will be able to supply.

Table 13 COMPONENTS OF THE RECLASSIFIED BALANCE SHEET

COMPONENTS

Fan

Average

IMPIEGHIFINANZIARI

100,0%

100,0%

CAPITALEFONDIARIO

76,6%

56,8%

plots

72,6%

38,2%

Rural buildings

4,0%

18,6%

CAPITALEAGRARIO

16,8%

39,6%

Cars

13,5%

30,2%

equipment

2,1%

7,8%

Closing inventory

0,3%

1,1%

Final cultural advances

0,8%

0,5%

LIQUIDITADIFFERITE

0,0%

0,6%

Credits

0,0%

0,6%

LIQUIDITAIMMEDIATE

6,6%

3,1%

Bank c / c

6,3%

2,8%

Cash desk

0,3%

0,3%

DEFINANCING SOURCES

100,0%

100,0%

PASSIVITACORRENTI

2,8%

10,5%

Providers

2,4%

9,5%

Accrued liabilities

0,3%

0,9%

PASSIVITACONSOLIDATE

13,5%

16,8%

Mortgages

13,5%

16,8%

OWN MEANS

83,7%

72,8%

Net capital

70,7%

63,5%

Profit from exercise

13,0%

9,2%


Mr. Ventola, thinking back to the last meeting with the trusted technician, prepares a small scheme with some technical information useful for integrating the company data already processed, and to then proceed with the calculation of the financial statement ratios, in order to obtain advice on his business situation The data entered in the scheme refer to the UAA, the power of the company machines, and the time worked in the company by the owner and his family. At this point, Mr. Ventola goes to Angelo to proceed to the analysis phase and proper, with this additional information (Tabella14).

Table 14 EXTRA-ACCOUNTING INFORMATION

SAU

35 HA

POWER

110 hp

LAVOROFAMILIARE

3,300 HOURS


Considering the limited availability of time of both, the two decide that on that occasion, they will only address the analysis of the company's technical expectations, postponing the income and financial-patrimonial part to other occasions. Before proceeding with the calculation of the technical parameters, Angelo must express the working hours used by Ventola and his wife, in terms of UL (full-time working unit in the company), on the basis of the equation that 1 UL = 2,200 birthday. So in the Ventola company there are 1.5 UL.
From the technical parameters (Table 15) which are calculated by the technician, some first considerations can be drawn, comparing the company values ​​with an average obtained from the companies assisted by the technician.

Table 15 TECHNICAL PARAMETERS

Index

Fan Company

Average reference

SAU / UL

23,3

21,3

HP / UL

73,3

76,2

KT / UL

21.588

66.102

K / UL

23.122

69.128

  • Firstly, there is a significant difference between the company in question and the reference value in relation to the indices that express the technical and agricultural capital per employee (KT / UL and K / UL). The difference can be attributed both to a lower capitalization of the Ventola company (perhaps resorting to subcontracting in a massive way), and to the fact that, despite being capitalized, the machines and equipment of the company in question are obsolete, and almost completely depreciated.

  • Again in relation to the machines, this time expressed in physical terms, and fifteen as power, there is a reduction in the difference between the two data, indicating that in the company there are still machines of a certain power, similar to that available in the other companies.

  • The indication that derives from the relationship between the Agricultural Area Used and the work units (SAU / UL) highlights a greater extensification of the use of the land, perhaps also linked to a better ability to organize and manage the activities in the company examined.

To these claims the entrepreneur confirms that in reality in his company the 110 hp tractor was purchased recently (in 1991) while the equipment is quite dated even if all of them are functioning, often subject to breakages, as in 1993 it happened for example for the seeder, or for the trailer, which was then replaced. One of the reasons why Mr. Ventola has an interest in conducting the company analysis is also linked to the assessment of economic convenience for the renewal of the equipment. Angelo adds to these initial indications that it would be appropriate in the future to keep a record of what has been calculated in order to also make comparisons of company data over time so as to highlight any structural changes.
For the examination of the economic and financial characteristics of the company, specific indices and quotients must be introduced for which they will meet the following week.


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