ENTERPRISE AND MARKET

THEORY
Monitoring the enterprise
business performance and ABC

prof. dr. Žiga Čepar

Contact: forum in e-classroom
Office hours: before lectures and upon agreement
Content
 Efficiency of business performance

 Income statement, Balance sheet and Financial flow

statemend

 Selection of sales plan and ABC method

 Analysing the enterprise‘s business operations

Efficiency of busines
performance
 It is evident from the business results that arise from the
profit and loss flow and are evident in the income
statement.

 It is also assessed on the basis of a comparison of individual

elements of the income statement and/or balance sheet.

 The final efficiency of business performance is the result of

efficiency performance in the field of:
• productivity
• operating efficiency ratio
• profitability

 When monitoring performance, we depend on the available

information (income statement, balance sheet), which is not
the same whether the enterprise is listed on a stock
exchange or not.
 Income statement (profit or loss)
is a financial statement in which are presented the
results of business operations in a certain period of time
(usually in one year).
REVENUES EXPENSES
ORDINARY REVENUES EXTRA ORDINARY EXPENSES EXTRA
 operating revenues ORDINARY  operating expenses ORDINARY
(value of sold products and REVENUES (costs included in sold EXPENSES
services) (e.g., cash products and services) (cash and
 revenues from and  expenses from warehousing
financing (e.g., interest on warehousing financing (e.g., interest on deficit, written-
given loans, interest from surpluses, borrowings, default off receivables,
customers, discounts subsidies, interests, discounts given, coverage of
received, positive exchange grants) negative exchange rate losses from
rate differences) differences) previous years
…)

INCOME STATEMENT (PROFIT or LOSS) = REVENUES – EXPENSES

Balance sheet (connection with the income
statement)
is a financial statement that presents BALANCE of assets
held by an enterprise on a given day, on the one hand,
and the origin of these assets, on the other hand
(liabilities).

ASSETS LIABILITIES
ASSETS (A) SOURCES OF ASSETS (L)
• Current assets • equity (E)
• Fixed assets • debts (D)
∆A ∆E
increase of A for profit or increase E for profit or
reduction for loss reduction for loss
 Financial flow statement
is a financial statement that shows financial inflows and outflows
(changes in financial assets) in a certain period (usually in
one year).
INFLOWS OUTLFOWS
Increase in financial resources*: Reduction in financial resources*:
due to business (paid sales) due to the reduction of liabilities,
due to new firm debts (financing) e.g., debt repayment (de-financing)
due to the reduction of the non- due to business investment, e.g.,

monetary part of assets, e.g., sale or increase in inventories, purchase of

impairment of fixed assets fixed assets (investment).
(disinvestment)

FINANCIAL RESULT = INFLOWS – OUTFLOWS

* Financial resources are:

•short- and long-term investments (bank deposits, bonds, shares, loans, derivates, etc.)
(bank deposits, bonds, shares, loans, derivatives, etc.)
•money: cash (cash in cash register) and book money (on current account as sight deposits)
FLOWS IN AN ENTERPRISE

 Profit and loss flows (+ revenues, –

expenses) are elements of the income
statement;

 Financial flows (+ inflows, – outflows) are

elements of the statement of financial flows;

 Money flows (+ (cash) receipts, – (cash)

payments) are elements of the recepits and
payments statement.
Define revenues and receipts and explain the
difference between them.
Revenues:
 they cover the value of sold products sold and conducted
services, revenues from financing and extraordinary revenues
(sales value of products may be transferred to operating revenues depending on the
accounting method: invoiced (charged) realization method/paid realization method);
 are a positive element of the profit and loss flow.

Receipts:
 mean an increase in the money balance in the enterprise's cash
register or on business account;
 are a positive element of money flow.

Financial inflows:
 increase the enterprise's financial resources;
 are a positive element of the financial flow associated with the
balance sheet.
 financial inflows occur due to:
 business operation (paid sales)
 increases of liabilities (financing),
 the reduction of the non-monetary part of assets
(disinvestment).
Expenses:
 are a negative element of profit and loss flows (income statement);
 they contain only the costs contained in the sold products/services.

Payments:
 a negative element of money flow that reduces the balance in a
business (bank) account or in the cash register.

Financial outflows:
 reduction of the enterprise's financial resources;
 is a negative element of the financial flow associated with the balance
sheet. It is caused by:
- de-financing (reduction of liabilities: repayment of debts or investments of owners);
- investments (increase in non-monetary assets: purchase of inventories or fixed
assets).

Costs:
 monetary value of consumed factors of production.

Consumption of inputs:
 physically (non-monetary) expressed consumption of production
factors in the production process
Define the basic types of profit or loss.
 Profit (difference between higher revenues and lower costs from
sold products and services: expenses):
 profit from ordinary activities
 operating profit (revenues from sales + possible subsidies and
the like - purchase value or costs of sold quantities - costs of
sales and administration)
 profit from financing (revenues from financing - expenses for
financing)
 extraordinary profit (extraordinary revenues - extraordinary
expenses).

 Net profit (profit less income taxes and other taxes). Scheduled:
 based on work (on employee profit shares) and
 on the basis of capital (dividends, on the increase of share
capital, on the formation of reserves, on the undistributed
part of net profit).

 Loss (difference between higher costs of sold products and

services or expenses and lower revenues).
 is shown as a deductible value adjustment of equity.
 is covered by debt write-offs, grants, ordinary activities,
reserves, retained earnings and other parts of capital
Define the extended types of profit or loss.
 contribution margin (TR-VC or P-AVC; covers fixed costs and
profits),

 gross profit (TR - production costs of sold quantities; covers non-

production costs and profit),

 price difference (TR - purchase value of merchandise),

 interest rate difference (the difference between the active interest

received by the bank and the passive interest paid by the bank),

 profit increased by financing expenses (profit or loss that the

enterprise would have achieved if it had not been financed by
loans) and

 income (sum of net profit, salary, taxes and contributions and

interest. It is also calculated as the difference between operating
revenues and costs of transferred value. Income is equal to the
newly created value and is divided into:
 workers with wages and shares of net profit (dividends),
 to lenders with interest and other charges,
 to owners with dividends and other allowances,
 the enterprise by forming reserves and retained earnings and
 state with taxes
Total contribution margin (CPK)

Variable
costs
Revenue Fixed Total
s costs contributi
Profit on margin
Gross profit

Production
costs
Revenu Non-production Gross
es costs profit
Profit
The difference in price

Purchase value of
Revenue merchandise
s Trading costs Differenc
Profit e in
price
 Profit increased for financing
expenses

Operating expenses and

extraordinary expenses
Revenue Expenses from financing Profit increased for
s financing expenses
Profit
Explain how revenues from sales, operating
revenues, revenues from financing,
extraordinary revenues, and total revenues
are related. Similarly, explain how operating
expenses, expenses from financing,
extraordinary expenses and total expenses
are related.
 PROFIT OR LOSS =
REVENUES - EXPENSES

REVENUES EXPENSES

EXTRAORDINARY EXTRAORDINARY
ORDINARY REVENUES REVENUES ORDINARY EXPENSES EXPENSES

Operating revenues Operating expenses

Revenues from financing Expenses from financing

Revenues are divided into:
 ordinary revenues:
 revenues from operation (are the product of the quantity of products and services
with their selling prices);
 revenues from financing (interests on loans and interests customers, discounts
received,
revaluations surplus and foreign exchange gains);
 extraordinary revenues (cash and warehousing surpluses, later paid already written
off received subsidies, grants and similar).

Expenses are divided into:

 ordinary expenses:
 expenses from operation (costs of materials, raw materials, foreign and own
services, depreciation, wages, costs of merchandise,
costs of sale and administration and similar)
 expenses from financing (interest on taken loans and for late payments to
suppliers, given discounts, foreign exchange losses,
costs of written-off long-term and short-term financial
investments, coverage of revaluation deficit);
 extraordinary expenses (cash and warehousing deficits, written-off receivables,
coverage of losses from previous years, formation of
provisions to cover possible losses from individual
transactions).
ABC method
What criteria are most commonly used to rank
products by their importance?

Different components of business (for example different

products) contribute differently to the final total
economic result (profit or loss) of a firm and use the limited
resources differently.

The more important product for the firm is the one that
contributes more to the business performance and uses less
resources of a an enterprise.
 ABC method is a methods for choosing production-sales plan
(or product mix) by the process of breaking down business
components according to their importance for the firm. It
belongs to linear programming methods.

 When arranging the products by their importance and when

determining their level of production we take into account market
(sales) constraints and production constraints and other restrictions
regarding available production resources (the available working
time …).

 The final result of the ABC method is the list of the quantities of
each particular product (the product mix) that an enterprise should
produce and sell in order to maximize profit.

 When choosing the production-sales plan using ABC method, we

most commonly use one of the following three criteria for
arranging the products by their importance:
 unit contribution margin: UCM=P-AVC
 unit contribution margin per working hour: (P-AVC)/h
 contribution margin ratio: CMR = (P-AVC)/P
Example of ABC method
An enterprise plans annual production and sales of three
different products. Altogether, 5,500 hours of work are
available per year, and the total fixed costs amount to €
24,000 €. Table below provides data by products.

Product Hours of work Selling Variable costs Production Sales

needed per price (€) per unit (€) constraint constraint
unit (unit) (units)
A 6 180 60 500 1,500
B 4 80 40 450 900
C 10 80 20 620 150
a) Determine the production-sales plan using the ABC method
according to the criterion of the contribution margin ratio and
calculate how much the profit of the enterprise would amount
to in that case.
b) What if there were a total of 6,500 working hours available?
SOLUTION:
a) First, we sort products by priority in a descending order
according to the criteria of contribution margin rate:
Product Contribution margin Descending
rate: (P-AVC)/P order
A 0.67 2.
B 0.50 3.
C 0.75 1.
 Example of ABC method
The enterprise plans annual production and sales of three different
products. Altogether, 5.500 hours of work are available per year, and the
total fixed costs amount to € 24.000 €. Table below provides data by
products
Product Required Selling Variable costs Production Sales
hours per price (€) per unit (€) constraint constraint
product (units) (unit)
A 6 180 60 500 1.500
B 4 80 40 450 900
C 10 80 20 620 150
a)Determine the production-sales plan using the ABC method according to
the criterion of the contribution margin ratio and calculate how much the
profit of the enterprise would amount to in that case.
SOLUTION:
Then we create a new table where rows are in a new "correct" order. Next
we determine Q taking into account all the constraints.

Required Production Market Planned

TCB (€)=
hours per P AVC constraint constr. production Required
Product product (€) (€) (units) (units) (Q) hours =(P-AVC)Q
C 10 80 20 620 150 150 1.500 9.000
A 6 180 60 500 1.500 500 3.000 60.000
B 4 80 40 450 900 250 1.000 10.000

ΣCPK=79.00
5.500 0ΣTCB
For the last product B 1.000 hours are left, which means that we could produce -FC = 24.000
with the remaining hours 250 units of product B only (1.000/4). π = 55.000
b) What if 6.500 working hours were availabe?

SOLUTION:
450 units of the last (B) product can now be produced. As a result, total
contribution margin increased for B as well as does the profit.
Required Production Market
TCB (€) =
hours per P AVC constraint constr. Planned Required
Product product (€) (€) (units) (units) production hours = (P-AVC)Q
C 10 80 20 620 150 150 1.500 9.000
A 6 180 60 500 1.500 500 3.000 60.000
B 4 80 40 450 900 // 450
500 // 1.800
2.000 18.000

6.500 ΣTCB=87.000
-FC = 24.000
Π = 63.000

For the last product B 2.000 hours are left, which means that we could produce 500 units of
product B (2.000/4) with the remaining hours.
However, we plan 450 units of product B only as allowed by the strictest (in this case
production) constraint, although we could produce 500 units considering the number of
hours of work left for B.
As a result, we only spend 450 x 4 = 1.800 hours for product B, which means that 2.000-
1.800 = 200 hours are unused. Profit is increased, because we can use full production
capacity in case of product B, which was not possible in the previous case.
Methods of analysing of
enterprise business
performance
 Method of decomposition or analysis (search for the
smallest elements of observation)

 Method of benchmarking or comparison

(comparison, benchmarking)

 Method of elimination (omission of irrelevant factors)

 Method of isolation (individual partial treatment of the
most important elements)

 Method of consolidation or synthesis (linking

individual findings into a whole picture)
Methods of analysing
enterprise business
performance
 Observing the overal business result (profit/loss)

 Calculating the ratios between the various items of

the balance sheet and income statement

 Most common groups of accounting indicators:

 financing indicators
 investment indicators
 indicators of the horizontal financial structure
 productivity indicators
 cost-effectiveness indicators
 profitability indicators
 operating efficiency indicators
 …
 ANALYSING
PROFIT-LOSS FLOW
(with indicators)

Productivity indicators Profitability indicators

* 100

Technical data from Balance sheet and income

Operating efficiency statement data
production
indicators

Income statement data

Define the most common productivity coefficients
(labour productivity coefficient, asset productivity
coefficient, fixed assets productivity coefficient,
material productivity coefficient and driving power
productivity coefficient).
Indicators of productivity

 Coefficient of labour productivity

 Coefficient of assets productivity

 Coefficient of fixed assets productivity

 Coefficient of material productivity

 Coefficient of driving power productivity

Define the most common operating efficiency ratios (ratio of
total operating efficiency, ratio of operating efficiency of
revenues, ratio of operating efficiency of financing, ratio of
technical operating efficiency, ratio of operating efficiency of
sales, rate of profit in revenues from sales and rate of value-
added in revenues from sales, etc…).
Indicators of operating efficiency
 Ratio of technical operating efficiency of products
OEpr. = sale value of products / cost value of products

 Ratio of technical operating efficiency of costs

OEcost = actual costs / precalculated costs

 Ratio of operating efficiency of total revenues

OETR = total revenues / total expenses

 Ratio of operating efficiency of operating revenues

OEOR = operating revenues / operating expenses

 Ratio of operating efficiency of sales
OES = revenues from sale / part of expenses from operation

 Ratio of operating efficiency of paid revenues

OEPR = paid revenues / expenses in paid revenues

 Ratio of operating efficiency of financing

OEF = revenues from financing / expenses from financing

 Rate of profit in revenues from sales

RPR/R = (profit from sales / revenues from sales) * 100

 Rate of value-added in revenues from sales

RVA/R = (value added / revenues from sales) * 100

Define the most common profitability indicators
(rate of return on equity, rate of return on debt, rate
of return on total liabilities and rate of return of
assets).
 Profitability indicators

 Rate of return on equity (ROE)

 Rate of return on debt

 Rate of return on total liabilities

 Rate of return on assets (ROA)

Applicability and interpretation
of business indicators
Value intervals for rate of return on assets and
rate of return on equity in various activities

Indicator Activity Value interval

ROA Services 5.1% - 11.2%
Trade 5.5% - 7.7%
Production 6.5% - 6.9%
ROE Services 9.5% - 18.2%
Trade 8.3% - 13.8%
Production 13.1% - 13.1%