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Capital budgeting (I) : investment decisions
X Unit 5 Slide 1
Summary
5.1 The financial position of the company
5.2 The assets of the company
5.3 The financial statements
5.4 Pro-forma financial statements and assets operations
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Capital Budgeting: Understanding Assets, Depreciation, and Pro-forma Financial Statements, Slide di Matematica Finanziaria
An in-depth analysis of the company's assets, focusing on current and fixed assets, and the concept of depreciation and amortization. It also covers the importance of pro-forma financial statements in investment decisions. Students will learn about the classification of assets, the difference between current and fixed assets, and the concept of depreciation and amortization. They will also gain an understanding of how to register the purchase, depreciation, and disposal of fixed assets, as well as the estimation of working capital.
Tipologia: Slide
2014/2015
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 1
Summary
5.1 The financial position of the company
5.2 The assets of the company
5.3 The financial statements
5.4 Pro-forma financial statements and assets operations
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 2
5.1 The financial position of the company
A company can be considered as a succession of investing and financing projects. The
following steps describe how a company works from a financial point of view:
- To acquire the desired investments, the company will need an amount of money. The company
has to raise the needed money by issuing capital or liabilities (debt) , thereby defining the
financial structure of the company. The financial structure of the company , therefore, is the
specific mixture of capital and liabilities a company uses to finance its operations. The company
commits itself to remunerate the fund providers in return.
- The firm uses the raised funds to acquire the different assets needed for the investment
project. An asset can be defined as any resource with economic value which is expected to
generate future cash-flows.
- By doing its operations, the assets of the company will be consumed and, as a
consequence, other assets of (expected) higher value will arise. For example, if a company
buys a good by 10 € and sell it by 12 €, the company will loose that good (that asset
“disappears” or it is consumed) but, in exchange, it receives a new asset which value is
higher (money or a credit). Therefore, the operations of the company are expected to
increase the value of the assets that belong to the company. The increasing in the value of
the assets of a company in a given period of time is called the Operating Income of that
period.
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 4
5.1 The financial position of the company
COMPANY
Net
Earnings
Net
Earnings
Stockholders
Debtholders
Capital
Capital
As the company does its operations…
Operating
Income
Operating
Income
Interests
Interests
Dividends
Reserves
Reserves
Debt
Debt
Assets
Assets
Assets Assets
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 5
5.1 The financial position of the company
- It is possible that the interests to be paid to the debtholders are higher than the
operating income. In this case, by substracting the interests to the operating income we
will get a negative net income, that is a net loss. In this case, the value of the
stockholders equity will decrease.
- Finally, it is also possible that, in the development of its operations, the company will
not receive assets of higher value, but assets of lower value. In this case, the
operations will produce an operating loss. In addition to that loss, the company will
still have to pay the interests to the debtholders, so those interests must be added to the
operating loss to produce an even larger net loss. Again, the value of the stockholders
equity will decrease.
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 7
5.2 The assets of the company
The assets of the company are the investments of that company. That is to say: an asset is
any economic resource controlled by the company which is expected to produce cash-
inflows in the future.
In the development of its operations, the assets of the company will disappear and they will
be replaced by other assets that are expected to be of the same or higher value. The
disappearance of an asset is called the consumption of that asset.
For example, let us consider the case of an industrial company. Its operations would be:
Buys raw materials
Convert raw materials
into finished products
Sell finished
products
Collect the
price
Money disappears
Raw materials appear
Raw materials disappear
Finished products appear
Finished products
disappear
Receivable
appears
Receivable
disappears
Money appears
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 8
5.2 The assets of the company
We can classify the assets into two groups depending on the time required to be
consumed. However, to make this classification, we have to define first the
company’s life cycle.
The company’s life cycle is composed of the set of procedures that take place in the
company from the moment in which the company makes an investment in its operations,
till the moment the invested money is returned.
The life cycle of a commercial and an industrial companies would be the following:
Goods
purchase
Goods sell
Collection of
receivables
Commercial
Commercial Industrial
Industrial
Raw material
acquisition
Production
Finished
goods sell
Collection of
receivables
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 10
5.2 The assets of the company
Fixed or noncurrent assets are those which will not be consumed in the company’s
life cycle.
Fixed assets
There are three main kinds of fixed assets:
A) Plant, property and equipment : tangible assets that are typically used in the
operations of the company. They comprise land, buildings, furniture and
equipment.
B) Intangible assets : assets that lack real substance, but they are expected to generate
future cash-flows. They usually represent rights, privileges and competitive
advantages backed by a legal agreement. Examples of intangible assets are patents,
copyrights, trademarks, goodwill, software licenses…
C) Long-term investments : financial investments of the company in another
company’s debt or equity, as well as long-term collection rights.
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 11
xed assets: amortization and depreciation
5.2 The assets of the company
Long-term invested will be consumed as the collection rights are fulfilled. Real
fixed assets (that is, those which are tangible or untangible assets), however, will be
consumed in the operations of the company, although they will not be fully
consumed in one single life cycle, but in various life cycles.
The partial consumption of the value of the fixed asset occurred in a period of time
is called depreciation (in the case of tangible assets) or amortization (in the case of
intangible assets).
Not all the tangible assets, however, are depreciated: land assets are not depreciated
because it is assumed to have an unlimited useful life, that is to say, it would be
consumed in infinitum life cycles.
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 13
5.2 The assets of the company
xed assets: amortization and depreciation
Example: the cost value of a car is 30,000 €. The company estimates that this car wil be
used during 4 years, being sold after that time by 5,000 €. Estimate the annual
depreciation of this car.
Useful life: 4 years
Depreciation basis:
Annual depreciation:
Example: the cost value of a car is 30,000 €. The company estimates that this car wil be
used until it has run 300,000 Km, being then sold by 5,000 €. If the car has run 130,
Km this year, estimate the depreciation for this year.
Useful life: 300,000 Km
Depreciation basis:
Depreciation per Km:
Depreciation for this year:
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 14
5.3 The financial statements
A financial statement is an official document of the firm which aim is to provide
information about the financial aspects of the firm.
There are three basic financial statements:
The Balance Sheet , which summarizes what a firm owns and owes at a point in ti
The Income Statement , which reports on how much a firm earned
in the period of analysis.
The Cash-flow Statement , which reports on cash inflows and outflows
to the firm during the period of analysis.
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 16
5.3 The financial statements
A possible design of the balance sheet from the point of view of accounting would be:
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 17
5.3 The financial statements
The income statement
It relates the company’s income and expenses during a given period and, by
difference, the net income earned during that period.
Income is any increase in the value of stockholder’s equity unrelated to
contributions from equity participants.
There are two types of income: revenue and gains. Revenue arises in the course
of the company’s ordinary activities as a consequence of the sale of the
inventoried elements (mainly, the sale of the finished goods) or the providing of a
service. Gains arise from the sale of a fixed asset for a price higher than its
accounting value.
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 19
5.3 The financial statements
Both income and expenses can be classified into Income/Expenses from assets
operations and Income/Expenses from financial operations, depending on if the
income/expense has been originated in an investing or a financing operations.
The income statement
Most income is related to assets operations. The sales revenue, the gains in the
disposal of fixed assets, or the revenues and gains on their financial investments are
income related to the investments of the company.
Income from financial operations is much less usual. The only example we will
study is the periodic recognition of the income generated by a grant.
Expenses related to assets operations are all those expenses the company has to incur
to produce and sell its products. For instance, the consumption of inventories,
depreciation, wages and salaries, services, losses in assets disposals….
Financial-related expenses are the interests paid for the money the company
borrows, as well as the commissions, fees and other costs associated to the liabilities
operations.
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Capital budgeting (I) : investment decisions
X Unit 5 Slide 20
5.3 The financial statements
One posible design of the balance sheet would be the following: