Benefits, costs and Benefits, costs and income statementincome statement

Expenses x CostsExpenses 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 RevenuesBenefits 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 themor services delivered to them

Benefits ≠ Revenues

Economic resultEconomic result

Economic result = Benefits – Costs

If:

Benefits > Costs → Profit

Benefits < Costs → Loss

Income statement Income statement (profit and loss account)(profit and loss account)

It sIt shows business hows business benefitsbenefits compared with compared with costscosts over over a given timea given time periodperiod (usually 1 year): (usually 1 year):

BenefitsBenefits 31. 12. 200X31. 12. 200X Costs Costs .. .. .. .. .. .. .. .. ∑ ∑ Benefits ∑ CostsBenefits ∑ Costs

Benefits > Costs → Profit (+) Costs < Benefits → Loss (-)

≠

What do you remember about What do you remember about costs?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 costsCategories of variable costs

According to the level of output:

a) same period → proportional costs,

b) faster→ progressive costs,

c) slowly → degressive costs.

Cost functionCost 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 descriptionCosts description

TC

FC

VC

Analysis of Break-Even pointAnalysis 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 AnalysisBreak-Even Analysis

A break-even point defines when an A break-even point defines when an investment will generate a positive returninvestment will generate a positive return..

Break-even analysis is a useful tool to Break-even analysis is a useful tool to study the relationship between fixed costs, study the relationship between fixed costs, variable costs and returnsvariable costs and returns..

Break-Even AnalysisBreak-Even Analysis

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

Break-even price analysis computes the Break-even price analysis computes the

price necessary at a given level of price necessary at a given level of production to cover all costsproduction to cover all costs..

Break-Even pointBreak-Even point

Break-even point (critical point of profitability) – volume (quantity) of production QBEP (Quantity of Break-Even Point), when total costs equals total revenues:

TR = TC

P * Q = FC + AVC * Q

Break-Even point Break-Even point - linear model -- linear model -

Break-Even pointBreak-Even point - non-linear model -- non-linear model -

point of maximum profit

Enterprise´s objectivesEnterprise´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 corporationValue of corporation

Present value of expected future net cash flow (profits) discounted to the present by the suitable discount rate.

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CF n corporatio of Value

CFi – expected future cash flow t

i – discount rate

Market Value AddedMarket 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 AddedEconomic Value Added

Economic Value Added = EVA

Difference between net profit of the enterprise and its costs of capital.

WACC*C - NOPAT EVA

WACC*C-T)-(1*EBITEVA

EBIT – Earnings Before Interest and TaxT – profit tax rate (decimal number)C – long-term invested capitalNOPAT – Net Operating Profit After Tax = profit after taxWACC – Weighted Average Costs of Capital (decimal number)

Economic Value AddedEconomic 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.

EBITEBIT

An advantage of An advantage of EBITEBIT - i- it is easier to t is easier to calculate and easier to observe calculate and easier to observe it it at at divisional or sub divisional levels of the divisional or sub divisional levels of the firm. firm.

Instead of Instead of EBITEBIT also the term Operating also the term Operating profit is widely used.profit is widely used.

WACCWACC

The cost of capital generally measured as The cost of capital generally measured as weighted average cost of capital (WACC).weighted average cost of capital (WACC).

WACC is the cost of debt, such as interest WACC is the cost of debt, such as interest on a loan, and the cost of equity on a loan, and the cost of equity investment, or rate of return. investment, or rate of return.

Optimal capital structureOptimal capital structure

= > rate of indebtedness

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

Average costs on capitalAverage costs on capital

V

Sk

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B*T)kWACC ei *1(*

WACC – weighted average costs on total capital (%)ki – costs on external capital before taxation of a profit (%)T – rate of profit´s taxation (decimal number)ke – costs on internal capital after taxation of a profit (%)B – market value of external capital in CZKV = B + S – total business capital in CZKS – market value of internal capital in CZK

Theory of U - curveTheory of U - curve

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0 10 20 30 40 50 60 70 80

Weighted Average Costs on Capital = WACC

indebtedness (%)

cost

s on

cap

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(%)

OPTIMUM

costs on internal capital ke

costs on external capital ki