ACTIVITY ONE
A Brief Company Profile
Lekwot & Sons Limited, a limited liability partnership business, was incorporated January 9, 2007. It is engaged in the sales of retail and wholesale consumer products in 2 major states of the federation, Nigeria. The Company does business in five strategic merchandise units, grocery, entertainment, health and wellness, apparel and home.
1. An assessment of why financial information is needed in business?
Firstly, Chamatam, (my new family member) will have to understand what financial information entails. Financial information involves processing financial data and cash flows of an individual or business organization to outline the financial status of that particular individual or business entity. The importance of financial information cannot be overemphasized, and it is against this backdrop Chamatam has to comprehend the essence of having financial skills.
According to Katarina & Lajos (2006 p.37), “assessment of financial information is necessary to convert data from financial statements into usable information for business quality measurement by adopting different analytical techniques, which is very important in the process of rational management” . On this basis, the benefit of financial information can be stated as follows:
• To make sure our financial resources are allocated optimally.
• To carry out proper financial analysis and planning.
• To manage our inventories by reducing the cost of ordering stocks and the cost of haulage.
• To determine our customers’ credit strength by evaluating our accounts receivables.
• To collate, and present accounting information regarding our company to management and stakeholders.
• To carry out and implement effective decisions affecting the business.
2. An identification of the business risks related to financial decisions:
Growth and profitability are two key elements for our company’s continuity and success. In this dynamic and competitive business environment, our company cannot manage either calculated or strategic business risk by employing a docile stance. It is against this backdrop that every member of our team has to develop the mindset, tools and skills necessary to explore the many facets of risk associated with each activity and opportunity to succeed in the business world.
What is business risk?
Business risk as defined by Investopedia is the possibility that a company will have lower than anticipated profits, or that it will experience a loss rather than a profit. The idea behind understanding the business risks associated with financial decisions is to guide against business failure by selecting a capital framework that has a lower debt ratio to enable our company meet its financial obligations consistently. There are five major kinds of risks, which are: financial risk, systematic risk, liquidity risk, exchange-rate risk and country-specific risk. Therefore, identifying business risks as it relates to financial decisions must cut-across these five major areas. The following outlined areas will have to be taken into cognizance in the course of identifying business risks as it relates to making financial decisions.
• Ensure a balance between our company’s debt and equity (financial leverage)
• Foresee risks associated with changes in industry regulation.
• Identify factors linked to supplier risk and changes in consumers’ demand.
• Identify operative risks, which may affect the company’s daily operations
• Initiate possible ways to mitigate risks associated with exchange rates. For example, continuous decline of the Naira against the dollar as experienced presently, can result to high import expenses resulting to high retail prices, which could discourage sales.
3. Summary of the financial information needed to make strategic business decisions:
Below is a statement of summarized report for strategic decision making. This summarized report will enable the user evaluate the past and current financial condition of our business, diagnose any existing financial problems, and forecast future patterns in our company’s financial position.
FIVE YEAR SAMPLE SUMMARY FOR LEKWOT & SONS LIMITED
Naira (N) in Millions 2015 2014 2013 2012 2011
Sales and other revenues 4,650 3,872 3,654 3,652 2,969
Net earnings 1,853 1,822 2,412 1,275 2,963
Adjusted operating earnings 1,936 1,875 2,312 1,640 3,201
Current Assets 7,620 6,850 6,210 5,860 5,673
Net property and other assets 5,727 4,762 4,544 3,871 3,675
Total Assets 21,786 19,181 19,132 16,298 18,481
Current noninterest-bearing liabilities 3,434 3,128 2,914 2,863 2,690
Debt 1,429 1,950 2,328 2,920 3,942
Other liabilities 4,310 4,008 4,224 4,216 3,856
Total stockholders’ equity 7,381 8,172 7,112 6,311 7,207
Total liabilities & stockholders’ equity 16,554 17,258 16,578 16,310 17,695
Table 1.0
ACTIVITY TWO
Published accounts for Simpson Manufacturing Co., Inc. (2014)
Report of the Directors and Published Financial Statements for Simpson Manufacturing Co., Inc.
Period of Accounts
Start date: January 1, 2013
End date: December 31, 2014
The directors present their report with the financial statements of the company and its subsidiaries for the period ended December 31, 2014 and 2013 in pursuant to Section 13 or 15(d) of the Securities and Exchange Act of 1934 for the fiscal year ended December 31, 2014.
Principal Activities:
The principal activity of the company in the period under review is: manufacturing of wood construction products and concrete construction products.
.
This report was approved by the board of directors in December 31, 2014 and signed on behalf of the Board by:
Name: Brian Magstadt
Status: Chief Financial Officer
Simpson Manufacturing Co. Inc.
Report of the Directors and
Unaudited Financial Statements
Periods of Accounts
Start date: January 1, 2013
End date: December 31, 2014
Simpson Manufacturing Co., Inc.
Contents of the Financial Statements
For the Period Ended December 31, 2014
Page
Company Information & Report of the Directors……………………………………………………… 7
Profit and Loss Account………………………………………………………………………………… 8
Balance Sheet…………………………………………………………………………………………… 9
Notes to the Financial Statements……………………………………………………………………….10
Simpson Manufacturing Co., Inc.
Company Information
For the Period Ended December 31, 2014
Company Information:
Simpson Manufacturing Co., Inc. is organized into three operating segments consisting of the North America, Europe and Asia/Pacific segments; through its subsidiary, Simpson Strong-Tie Company Inc. designs, engineers and is a leading manufacturer of wood construction products, including connectors, truss plates, fastening systems, fasteners and pre-fabricated lateral systems used in light-frame construction, and concrete construction products used for concrete, masonry, steel and for concrete repair, protection and strengthening, including adhesives, chemicals, mechanical anchors, carbide drill bits, powder actuated tools and fiber reinforced materials. SST markets its products to the residential construction, light industrial and commercial construction, remodeling and do-it-yourself (“DIY”) markets.
Report of Independent Registered Public Accounting Firm:
To the Board of Directors and Stockholders of Simpson manufacturing Co., Inc.:
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all materials respects, the financial position of Simpson Manufacturing Co., Inc. and its subsidiaries at December 31, 2014 and 2013 and the results of their operations and their cash flows for the three years in the period ended December 31, 2014 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index presents fairy, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2o14, based on criteria established in internal control.
The company’s management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under Item 9A.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Simpson Manufacturing Co., Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except per share data)
2014 2013
$ $
Net sales: 752,148 705,322
Cost of Sales: 410,118 391,791
Gross Profit 342,030 313,531
Operating expenses
Research and development and other engineering 39,018 233,593
Selling 21,955 26,346
General and administrative 111,500 108,070
Impairment of goodwill 530 –
Net loss (gain) on disposal of assets (325) 2,038
242,754 232,053
Income from operations 99,276 81,478
Interest income 901 987
Interest expense (855) (901)
Income before taxes 99,322 81,564
Provision for income taxes 35,791 30,593
Net income $ 63,531 $ 50,791
Earnings per common share:
Basic $ 1.30 $ 1.05
Diluted $ 1.29 $ 1.05
Weighted average number of shares outstanding
Basic 48,977 48,521
Diluted 49,194 48,673
Simpson Manufacturing Co., Inc. and Subsidiaries
Consolidated Statements of Operations
(In thousands, except per share data)
2014 2013
$ $
ASSETS
Current assets:
Cash and cash equivalents 260,307 22,000
Trade accounts receivable, net 92,015 90,017
Inventories 216,545 197,728
Deferred income taxes 14,662 16,611
Other current assets 20,789 16,454
Total current assets 604,318 571,018
Property, plant and equipment, net 207,027 209,533
Goodwill 123,881 129,218
Intangible assets 32,587 41,773
Other noncurrent assets 5,252 4,983
Total assets: $ 333,609 $ 312,894
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Line of credit and notes payable 18 103
Trade accounts payable 22,860 34,933
Accrued liabilities 56,078 51,745
Accrued profit sharing trust contributions 5,384 5,784
Accrued cash profit sharing and commissions 6,039 6,049
Accrued workers’ compensation 4,101 4,591
Total current liabilities 94,480 103,205
Long-term liabilities 15,120 12,041
Total liabilities 109,600 115,246
Commitments and contingencies
Stockholders’ equity
Preferred stock, par value $0.01; authorized shares, 5,000;
Issued and outstanding shares none – –
Common stock, par value $0.01; authorized shares, 160,000; issued and outstanding
Shares, 48,966 and 48,712 at December 31, 2014
and 2013, respectively 489 486
Additional paid-in capital 220,982 207,418 Retained earnings 649,174 615,289
Accumulated other comprehensive income (loss) (7,180) 18,086
Total stockholders’ equity 863,465 841,279
Total liabilities and stockholders’ equity $ 973,065 $ 956,525
These accounts have been prepared in accordance with the Accounting Standards Codification (ASC) issued by FASB, in April 2014.
The undersigned, Karen Colonias and Brian J. Magstadt, being the duly elected and acting Chief Executive Officer and Chief Financial Officer, respectively, of Simpson Manufacturing Co., Inc., a Delaware corporation (the “Company”), hereby certify that the annual report of the Company on Form 10-K for the year ended December 31, 2014, fully complies with the requirements of section 13(a) or 15(d) of the Securities and Exchange Act of 1934, as amended, and that information contained in such report fairly presents, in all material respects, the financial condition and results of operations of the company.
DATE: March 2, 2015 By /s/Brian J. Magstadt
Brian J. Magstadt
Chief Financial Officer
1. An explanation of the purpose, structure and content of a published account
Profit and Loss Account:
The aim of the profit and loss account (also referred to as Income Statement) is to give a progressive report or an overview of the business performance over a period of time. According to VSBDC (2011), the report reflects the company’s chosen financial year, for tax purposes, the owner may need to prepare a second income statement based on the calendar year, if the fiscal year is different. This statement is broken down into sales, expenses and operating income (or loss). It shows the profit margin, expenses (general and administrative) and the net profit of the business.
Balance Sheet:
The aim of the balance sheet is to furnish users of the statement with information on what the business owns. The VSBDC (2011) posits that the backbone of the Balance Sheet is the fundamental accounting equation: Assets = Liabilities + Equity (transposed: Assets – Liabilities = Equity). This equation is based on the accounting principle that every business transaction, such as selling merchandise or borrowing capital, has a dual effect. This statement is divided into two major parts, consisting of the assets and the liabilities. These divisions are generally prepared in the double-column account format, with assets on the left, and liabilities and equity on the right. Alternatively, the one-column account format list s the assets above, liabilities and equity below. Any change in one part, requires a simultaneous change in the other part, to ensure equilibrium between the assets and liabilities. Any imbalance is an indication of poor calculations or incomplete records. The assets are broken down into the current and fixed assets; while the liabilities are categorized into the short term and long term liabilities.
2. Interpretation of the financial reports above
The following is a discussion and analysis of the consolidated financial condition and results of operations for Simpson Manufacturing Co., Inc. and Subsidiaries for the years December 31, 2014 and December 31, 2013,
Cost of sales increased by $18,327 from 2013 to 2014, representing a 4.7 percent, and this has lowered the gross profit margins by the end of 2014. While gross profit increased from $313,531 in 2013 to $342,030 in 2014 representing a percentage increase of 9.08 percent. This rise in gross profit shows an increasing efficiency and profitability between 2013 and 2014. The operating profit which in the financial report above, represents the Income from operations indicates that the profit the company made after subtracting sales and SG&A from 2013 to 2014 is considerably low; this means that Simpson Manufacturing Co. needs to focus more attention on sales to match their operating cost.
The net profit grew by $12,560 from 2013 to 2014, representing 24.6 percent. The net income which stands for the company’s profit after all financial expenditures have been deducted shows a positive result, indicating the company’s ability to amass a favorable customer base amidst competitors. This will enable the management of Simpson Manufacturing Co. Inc. to make decisions that will protect the company against economic recession and financial shocks.
The financial status of Simpson Manufacturing Co. Inc can be ascertained by its assets, liabilities and stockholders’ equity. Simpson Manufacturing Co.’s inventories rose by $18,817 (9.5 percent increase) which has affected cash in hand. A close observation shows that inventory in 2014 ($216,545) was close to the amount of cash and its equivalent ($260,307) the company had in 2014. This can be attributed to the increase in inventory as a result of low sales of stocks. The total assets did not indicate any significant growth between the two financial years, rising by just 1.7 percent.
Current liabilities which are the company’s financial commitments to external sources within a period of one year dropped by 8.4 percent in 2014; this is an indication that the company were able to meet with some of its short-term payment within the 2013-2014 fiscal year.
The long-term liabilities rose by $3,079, which can be attributed to the company’s involvement in the purchase of tangible and long-term assets, as well as other financial borrowing to run the company.
3. Financial ratios from the accounts above
When computing financial relationships, an explanation of the business’ financial strengths and weaknesses becomes obvious.
The following are the most critical ratios for most businesses, though there are others that may not be computed. For the purpose of this file, we will restrict our analysis to the year 2014. And for the average accounts receivables, 2013 & 2014 will be adopted.
i. Liquidity: this ratio determines the business’ capacity to indemnify its debts as at when due.
Current ratio – this ratio indicates a company’s ability to meet current demands via current assets only. It is also referred to as the working capital ratio; the criterion for the current ratio is 2 to1 (2:1, or 2/1).
The formula is:
Total Current Assets
Total Current Liabilities
= 973065 = 1.92
94480
Observation: The result indicates a low liquidity ratio, which suggests that the company may struggle to meet up with their current liabilities; but usually, the industry average may be a better index for any subsequent strategic decision the management may want to make. More priority should be given to the management of the company’s assets.
ii. Safety: this critical ratio indicates a business’ level of exposure to risk – meaning, the degree of protection provided for the business against its creditors (borrowed monies). It is simply meant to measure safety.
Debt to worth – this is also referred to as the company’s net worth. It shows the correlation between the capital invested by owners and investors and the funds provided by creditors. A high ratio is an indication of a high risk to a current or future creditor. A lower financial ratio means that the business is financially stable and is probably in a better position to borrow presently and in time to come.
The formula is:
Total Liabilities (or Debt)
Net Worth (or Total Equity)
= 109600 = 0.12
863465
Observation: The outcome of this ratio seems to be very encouraging because it is very low. This means that the capital invested by the owners far exceeds the company’s debt profile, indicating a high degree of protection against any financial shock.
iii. Profitability: this major ratio measures the business’ ability to raise returns on its resources. These ratios can be used to determine if the business is profitable. An upward surge in the ratio is viewed as a positive sign.
Gross profit margin – this margin indicates how the company can raise returns at the gross profit level. It addresses three main areas: inventory control, pricing and production efficiency.
The formula is:
Gross Profit
Total Sales
= 342030 = 0.45
752148
Observation: returns from the gross profit seem to be low, which means that inventories and pricing has to be looked into by the management, to raise the ratio.
Net Profit Margin – this margin indicates how much net profit originates from every Naira of total sales. It shows how well the business has managed its operating expenses, it can also indicate the company’s volume of sales, to compensate for the minimum fixed costs, and still have reasonable profit left.
The formula is:
Net Profit
Total Sales
= 63531 = 0.08
752148
Observation: the company obviously realizes very low net profit from every dollar of total sales, which means that it has to generate more sales to cover fixed and variable expenses.
iv. Efficiency: this ratio estimates proper management of the business’ assets. This ratio also evaluates how effectively the company employs its assets.
Accounts Receivable Turnover – Shows the frequency of payments for the accounts receivable during the accounting period. A high turnover is an indication that the company is collecting its receivables fast, which is an indication of increased cash on hand.
The formula is:
Total Net Sales
Average Accounts Receivable
= 752148 = 4.13
92015 + 90017
Observation: the turnover rate seems to be low at 4.13, this means that the company has to improve on collection of receivables, speed up collections to improve on available liquid resources.
ACTIVITY THREE
1. An explanation distinguishing the requirements for long-term and short-term financing
Short-term Financing:
According to Dealflow, short-term finance is a type of debt that entails financial commitments that must be actualized annually or biannually at most. They include: overdraft, letter of credit, short-term loan and bill of exchange.
Businesses are required to have:
• A workable and feasible business plan and goals
• A start-up capital
• Viability
• Clear-cut and translucent financial services
• A positive and genuine reputation in the sector it operates.
Long-term Financing:
As posited by Dealflow, long-term financing cuts across business investments that usually involve protracted re-imbursement periods, usually above two years. For example: 5 years to 10 years, 20 years or more. Purchases of tangible assets by a company may require long-term financing. They include: term loan and leasing.
Due to the risk involved in long-term financing, businesses are usually required to:
• Commit collateral, in other words, ‘security’ in case of default
• Have valuable tangible assets
• Have a favorable debt profile (credit worthiness)
• Have favorable financial indices or financial ratios (liquidity, profitability and cash flows).
• A current audited financial report or statement, to enable the financing company determine their credit worthiness.
2. Table comparing source of long-term and short-term finance for businesses
Sources of Long-Term and Short-Term Finance
S/n Long-Term Finance Short-Term Finance
1. Lengthy period of time is involved Negotiation is easy
2. Higher risk Minimum burden on the borrowing company
3. The framework is well designed due to the technicalities associated with long-term finance Servicing short-term loans is less demanding with short-term finance
4. They are usually secured, so they are resistant to short-term challenges Lesser difficulty in monitoring short-term loans
5. Adequate information is usually required from long-term borrowers Short-term financing requires a brief duration
6. Protracted negotiation periods Lesser risk
Table 3.0
3. Examination of cash flow management techniques:
According to business news daily, Cash flow management is a term used to describe the practice of balancing income to expenses. Companies cannot spend money they have not received, which means they need to appropriately project when they anticipate receiving cash as part of a sales, investment or contract, and have that money in hand for expenses as they arise” (Business News Daily, 2016).Cash flow management is a deliberate effort aimed at creating equilibrium between a company’s income and expenses; it is important because it aids the prevention of operational crises by applying required fundamental principles to the success of the business. It is usually difficult for small businesses to remain atop cash flow management; therefore, they have to adopt the following techniques to manage their cash flows effectively.
• Source for a loan facility from an individual investor or a financial institution
• Expedite their collection process
• Convert tangible assets into liquidity
• Secure a non-cash means of acquiring long term assets (equipment) through leasing, hire purchase or loans
• Approach a banking firm for line of credit
• Prolong their accounts payable, and payments to creditors.
ACTIVITY FOUR
1. Business ownership structures and analysis of corporate governance
In the course of setting up a business, the form of business entity has to be considered before the business is established. The type of business structure you select, determines the income tax return form that will be issued to the company. Business structures are classified into: sole proprietorship, partnership, private limited liability companies (Ltd), public limited liability companies (plc) and Joint Stock Company.
• Sole Proprietorship:
Anyone who intends operating his/her business alone can opt for this business structure. This is the simplest form of business structure, which usually involves one-man operation. The proprietor owns all the assets of the company, and bears unlimited liability for any of the company’s debt or liabilities.
Legally, the business and the owner are fused together; which simply means that, the owner could suffer loss of personal assets if the company runs into solvency challenges. In terms of taxes, as posited by the Entrepreneur (2016), “the sole proprietorship is encouraging, due to the inclusion of income and expenditure on the personal income tax return Form 1040 (Schedule SE 1040 form). For the sole proprietorship, the owner is meant to make quadruple equal payments annually; April 15, June, September and January. Taxes for a sole proprietor are taxed once every month. The major advantage is the fact that the owner has absolute control over the business.
• Partnership:
According to Larry, “the partnership Act of 1890 is an Act of the parliament of the United Kingdom which governs the rights and duties of people who carry on business in common with a view of maximizing profit” (Larry, 2013). The Act defines as where two or more people carry on business with a common view of profit. The legal requirement is the Deed of partnership; which is a document that constitutes the business and provides rules and regulations that guides the company. The business is operated in such a way that all partners are involved in the management of the business, except otherwise agreed upon. In terms of decision making, a simple majority is all that it takes for partners to arrive at a decision.
Financially, the Act makes provision for equality among members. This means that, capital is contributed equally among the partners, profits and losses are shared equally also. In a situation where a partner contributes less capital, he/she is entitled to the percentage of his contribution to the start-up capital. The following are contained in the Deed of partnership:
i. The amount of capital to be provided by each partner
ii. The formula for sharing profit and losses
iii. The number of votes each partner is entitled to; which is usually based on the proportion of capital contributed from the time the business is established
iv. Code of regulations regarding the absorption of a new entrant
v. Regulations on how the partnership is dissolved or exit of a member partner
• Private Limited Liability Company:
Two or more people can form or incorporate a private limited liability company. Larry posits that “private limited liabilities companies as required by law must have a membership from 2 – 50 except bonafide employees of the company” (Larry, 2013). This type of business structure brings together a good number of the best features of partnerships and corporations. The private limited liability companies where set up by law to bring the benefits of liability cover that corporations enjoy without double taxation.
To establish a private limited liability company, the partners must file articles of organization with the secretary of state where the business will be domiciled, and also an operations agreement, which may be similar to the Deed of partnership. A recent introduction into the laws guiding private limited liability companies is that, partners will be accountable for their individual malpractice, and not that of their partners. This legal framework is best suited for businesses that are involved in the medical fields.
The start-up capital is divided into shares which are not declared publicly i.e. on the Stock Exchange Market. These shares are purchased internally; via private placement, which is contained in the articles of association by law, hindering the transfer of shares publicly.
• Public Limited Liability Company:
The public limited liability company on the other hand is operated such that its shares are made public for any interested investor to purchase their shares on the floor of the stack exchange market, via a stock broker. A foreigner or an alien company can float its company shares in the stock market, subject to the provisions of the law regulating the rights and capacity of foreigners to engage and trade in business in the host country. In Nigeria, non-Nigerians can freely invest and participate in the operation of any enterprise in the country, excluding those companies that have a record of fraud (black-listed companies). “A public limited liability company must have at least 500,000 authorized share capital and the subscribers must take up at least twenty five percent of the authorized share capital” (NigeriaFormations, 2013). Due to the huge capital requirements, running a public limited liability company is not economical; therefore, it is usually suitable for large organizations, and not private limited liability company.
• Joint Stock Company:
This type of business structure is composed of the public limited liability company and private limited liability company fused together wholly owned by shares. This structure requires pooling the resources of both the private and public company to a common purse to yield high profit. A typical example of a joint venture company in Nigeria is the Shell Petroleum Development Company Limited (SPDC), also known as Shell Nigeria. It is a joint venture comprising of the Nigerian National Petroleum Corporation (NNPC), shell, TotalFinaElf and Agip.
Reasons why joint stock company is preferable to other business structures
Presence of large capital base (liquid resources)
Existence of limited liability
Efficient technical know-how
Large-scale production (economies of scale)
Research and Development
2. An evaluation of methods for appraising strategic capital or investment projects
The methods for carrying out an evaluation of methods for appraising strategic capital or investment or investment projects can be categorized into two branches, namely: discounted cash flows and the non-discounted cash flows.
The Discounted Cash Flow (DCF):
This involves the capital decisions made by taking into cognizance the interest money in hand can yield if invested in a bank or project. The discounted cash flow methods include, net present value (NPV), internal rate of return (IRR), profitability index (PI) and payback period (PBP).
The Non-Discounted Cash Flow (NDCF):
The NDCF relates to making capital decisions without putting into consideration the interest the money in hand will yield if invested in a bank or project. The non-discounted cash flow method involves the payback period.
Evaluation Methods for Appraising Capital Projects:
Future Value (FV): this method of appraisal depicts the future value of an investment on the basis of a periodic, constant payment at a specific interest rate. Future value is calculated thus:
FV = PV*(1+K)n
Where: PV = present value
K= discount rate
n = number of years
For example: If N100000 is invested in a bank today may earn 6 percent per annum. What is the future value of N100000 for the first, third and tenth year?
After one year (n=1): FV = 100000(1+ (6/100)) 1 = 100000(1.06)1 = N106, 000
After three years (n=3): FV = 100000(1+ (6/100)) 3 = 100000(1.06)3 = N119, 101.6
After ten years (n=10): FV = 100000(1+ (6/100)) 10 = 100000(1.06)10 = N179, 084.7
Present Value (PV): the present value is the total amount of money that a sequence of future investments is worth now. The formula for calculating present value is:
PV = FV * 1
(1+K) n
Where: fv = future value
K= discount rate
n = number of years
For example: If N100000 (future value) is invested in a bank today may earn 6 percent per annum. What is the present value of N100000 for the first, third and tenth year?
After one year (n=1): PV = 100000(1/ (1+6/100)) 1 = 100000(1/1.06)1 = N 94,339.62
After three years (n=3): PV = 100000(1/ (1+ (6/100)) 3 = 100000(1/1.06)3 = N 83.961.92
After ten years (n=10): PV = 100000(1/ (1+ (6/100)) 10 = 100000(1/1.06)10 = N 55,839.47
Net Present Value:
Net present value is obtained by subtracting the present value of all cash outflows from the present value of all the cash inflows. The net present value is adopted as an index to accept or reject an investment project, like purchasing tangible long term assets, purchase of inventory and possible expansion of the firm’s operations when the NPV is positive and rejected when is negative. In other words, when the returns or earnings exceed the cost of the investment, the investment is positive.
The formula is:
Net present value = PV of cash inflows – PV of cash outflows
For example: a sum of N 400,000 invested today in a Telecommunications project at a 6% discount rate, may give a series of cash inflows below in future:
N 60,000 in year 1
N 120,000 in year 2
N 150,000 in year 3
N 150,000 in year 4
N 50,000 in year 5
YEAR EXPECTED CASH INFLOWS (N) PV OF CASH INFLOWS (N) PV OF CASH OUTFLOW (N)
1 60, 000 56, 603.7 400, 000
2 120, 000 106, 799.5 –
3 150, 000 125, 942.8 –
4 150.000 125, 942.8 –
5 50,000 37, 362.9 –
Total 452, 651.7 400, 000
Table 4.0
NPV = 452651.7 – 400000 = N 52,651.7
Therefore, with the above result, the manager can decide to invest in the project.
Internal Rate of Return (IRR):
This method of capital appraisal is the calculation which enables us to decide how much rate of return we are gaining from the project. IRR is a discount rate that equates the net present value (NPV) of all cash flows from a particular project to zero; this is obtained by increasing the discount rate, until the NPV reaches zero. The IRR is used to grade projects. If the IRR of a project is greater than the discount rate, then the company should invest in that project, and if the IRR is less than the discount rate, then the project is not financially viable, therefore, it should be rejected.
Profitability Index:
This is a decision making approach of investment appraisal that indicates to a business manager the amount of Naira that is returned for each Naira spent. Knowledge of the NPV’s cash inflows and cash outflows is necessary; because the cash inflows will be divided by the cash outflows. The project the company wants to invest in should be accepted if the profitability index is greater than one, or declined if the profitability index is less than one.
The formula for P.I. is:
Profitability index = present value of all future cash inflows
Initial cash outflows
For example: a sum of N 500,000 invested today in a leasing project at 8% interest rate, may give a series of cash inflows below in future:
N 70,000 in year 1
N 110,000 in year 2
N 130,000 in year 3
N 130,000 in year 4
N 80,000 in year 5
YEAR EXPECTED CASH INFLOWS (N) PV OF CASH INFLOWS (N) PV OF CASH OUTFLOW (N)
1 70, 000 64, 814.8 500, 000
2 110, 000 94, 307.2 –
3 130, 000 103, 198.1 –
4 130.000 95, 553.8 –
5 80,000 54, 446.6 –
Total 412, 320.5 500, 000
Table 4.1
Profitability index = 412320.5 = 0.824
500000
Based on the outcome of the calculation above, the idea of investing into this leasing project has to be rejected; because the profitability index is less than one.
Payback Period (PBP):
The payback period is the length of time it takes the company to recover the initial cash outflows. Businesses do not consider the time value of money when adopting the payback period; this is due to fact that the company will have to base its analysis on the number of years it will take the business to recover the cash outflows invested into the project.
The strategic managers will accept the project if the payback period is commensurate to the industry trend, which may be less than the maximum payback period associated with that particular industry standard.
For example:
A sum of N 100,000 is invested in a small scale business venture, the expected cash inflows in future are enumerated below:
N 28,000 in the first year
N 40,000 in the second year
N 55,000 in the third year
N 35,000 in the fourth year
N 30,000 in the fifth year
What will be the payback period without a discount rate?
Initial Cash Outlay = N 100,000
Cumulative Non-discounted Cash Inflow in Naira (N)
End of Year 1: 28000
End of Year 2: 40000
End of Year 3: 55000
End of Year 4: 35000
End of Year 5: 30000
Payback Period (Non-discounted)
Year Cash Inflow (N) Cumulative Cash Inflows (N)
1 24000 24000
2 38000 62000
3 50000 103666.66
4 33000 136666.66
5 30000 166666.66
PBP 3 years 10months
Table 4.2
The payback period in months is obtained by dividing the N50, 000 by 12 months (N 4166.66) and each month summed up to (N 4166.66 * 10 = N 41666.6), and added to the cumulative amount in the second year; (N62, 000), hence, the total sum of N103, 666.67K in the third year.
References:
1. Deal Flow Connection (2016) Debt Financing: Short-Term Debt Financing. [Online] http://www.dealflow.org.sg/cms/services/financing_for_smes_debt_financing.asp [Accessed 19 March 2016]
2. Entrepreneur (2016) Business Structure Basics. Fifth Edition. Entrepreneur Press. [Online] http://www.entrepreneur.com/article /75118
3. Katarina, Z & Lajos, Z (2006) The Role of Financial Information in Decision Making Process. Special Edition. [Online]
http://businessperspective.org/journals_Free/im/2006/im_en_2006/im_en_2006_03_Zager.pdf
4. NIGERIAFORMATIONS (2013) Types of Companies in Nigeria. [Online] www.nigeriaformations.com/types-of-companies-in-Nigeria
5. Ryan Goodrich (2013) Cash Flow Management: Techniques & Tools [Online] www.businessnewsdaily.com/4635-cash-flow-management.html
6. Simpson Manufacturing Co. Inc. (2015) 2014 Annual Report. [Online]
http://www.simpsonmfg.com/docs/AnnualReport2014.pdf
7. Virginia Small Business Development Center Network (2011) Financial Statement Analysis for Small Businesses. [Online]
http://www.hrsbdc.org/wp_content/uploads/2011/04/vsbdcFinancialStatementResourceGuide.pdf
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