Financial Management

Dr. Eslam Abd El-Hamid

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THE BREAKEVEN POINT
 EXPENSES CLASSIFICATION

3 • Variable Costs and Fixed Costs

– All the costs faced by companies can be broken into two main
categories: fixed costs and variable costs.
• Fixed costs are costs that are independent of output. These
remain constant throughout the relevant range and are usually
considered sunk for the relevant range (not relevant to output
decisions). Fixed costs often include rent, buildings, machinery,
etc.
 EXPENSES CLASSIFICATION

4 • Variable Costs and Fixed Costs

• Variable costs are costs that vary with output. Generally variable
costs increase at a constant rate relative to labor and capital.
Variable costs may include wages, utilities, materials used in
production, etc.
 EXPENSES CLASSIFICATION

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• Breakeven Point
– The break-even point is the level of sales at which revenue equals
expenses and net income is zero.
 BREAKEVEN POINT

• To compute a company's breakeven point in sales volume,

you need to know the values of three variables:
– Fixed costs: Costs that are independent of sales volume, such as
rent
– Variable costs: Costs that are dependent on sales volume, such
as the cost of manufacturing the product
– Selling price of the product
 CASE (2)

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EXAMPLE:
Fixed costs (F) = $40,000
Selling price per unit (P) = $10
Variable cost per unit (V) = $6
1. What is the break-even point in units?
2. What is the break-even point in dollars?
 CASE (2)

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1. Let X = break-even point in units

Net income = Sales revenue - Variable expenses - Fixed expenses

0 = $10X -$6X - $40,000
$10X - $6X = $40,000
$4X = $40,000
X = 10,000 units

2. Break-even point in sales dollars = 10,000 x $10 = $100,000

3. Break-even point in dollars = $ 40,000 ÷ Contribution Margin Ratio
= $ 40,000 ÷ (1- “VC ÷ Price”) = 40,000 ÷ (1 – (6/10))
= $40,000 ÷ 40% = $ 100,000
Module Two:
Understanding Major Financial Statements
 INTRODUCTION

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• One statement cannot diagnose your company’s financial health. Put

several statements together and you can make smart financial,
investment and management decisions.
 What are these Statements?

11 • Financial statements are meaningful, writ ten re cords which al low you
to diagnose your financial strengths and weak nesses and increase the
life and profitability of your company.
• The financial Statements that the company produces these include:

– Balance Sheet

– Income Statement

– Cash Flow Statement

 WHAT ARE THESE STATEMENTS?

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Balance Sheet
• What a company owns, what it owes, and what is left over.

Income Statement
• A Firm’s sales and expenses plus its profit or loss.

Cash Flow Statement

• The sources, uses, and balance of cash, shown on a
monthly basis.
Balance Sheet
 1. BALANCE SHEET

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• This statement shows what you own (assets), what you owe
(liabilities), and what’s left over (net value or equity in the
business). The numbers change every time you receive money
or give credit to a client as well as when you pay for or charge
an expense.
 1. BALANCE SHEET

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• The balance sheet is divided into two halves:

– Assets
– Liabilities and Shareholders’ Equity
• Liabilities
• Shareholders’ Equity
 1. BALANCE SHEET

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• What it Shows You?

– The net value of the business
– How much of your loan debt is current, and how much is long-term
– Percentages and ratios (which are extracted from the numbers)
necessary to analyze your business (see Ratios section)
 1. BALANCE SHEET

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• Compare two of the same time periods to see changes in:

– Cash
– Accounts Payable
– Accounts Receivable
– Equity
– Inventory
– Retained Earnings
 1. BALANCE SHEET

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 CASE 3 - BALANCE SHEET PROBLEM

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• Identify the criteria of the following items (Assets, Liabilities or Owner Equity):
Create Balance Sheet from Following items
• Notes payable 22,400
• Inventory 55,000
• Account receivable 9,600
• Capital 72,000
• Account payable 43,200
• Building, Land and Equipment 96,000
• Short Term Loan or Short term debt 5,000
• Office supplies 12,000
• Retained earnings 34,800
• Cash 4,800
Income Statement
 2. INCOME STATEMENTS

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• The most important report for many analysts, investors or

potential investors is the income statement. It shows how
much the corporation earned or lost during the year.
• Other names for this statement
– Operating statement
– Earnings statement
– Profit & Loss statement (P&L)
 2. INCOME STATEMENTS

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• An income statement matches the revenues earned from selling

goods and services or other activities against all the costs and
outlays incurred to operate the company.
• The difference is the net income (or loss) for the year. The costs
incurred usually consist of:
– Cost of sales; selling, general
– and administrative expenses, such as wages and salaries, rent, supplies
– and depreciation; interest on money borrowed;
– and taxes.
 2. INCOME STATEMENTS

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• What Does an Income Statement Tell you?

– In the day-to-day running of your business, numbers fly around at a
dizzying pace.
– Bills are paid, money is taken in, and sometimes, in this whirlwind of
activity, it’s hard to know how much you’re actually making.
– The Income Statement answers that question.
 2. INCOME STATEMENTS

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• What it Shows You?

– If sales are going up or down
– Your gross profit — how much money is left for the rest of the
business after deducting what it costs to produce or purchase the
product
– All expenses for the time period it covers
– Increases and decreases in net income
– How much money is left to grow the business
– How much money is left for the owner(s)
– How much money is left to pay debt (principal only)
 2. INCOME STATEMENTS

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 CASE 4 – INCOME STATEMENT ANALYSIS

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Cash Flow Statement
 3. CASH FLOW STATEMENT

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• The third critical financial statement, along with the balance

sheet and the income statement, is called the statement of
cash flows, which is a more accurate description of the
information it contains.
• It describes in summary form how the company generated the
cash flows it needed (sources) to finance its various financial
opportunities and responsibilities (uses) during the past year.
 3. CASH FLOW STATEMENT

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• There are three main components of the statement of cash

flows. They are the following:
– Cash flow from operations
– Cash flow from investing
– Cash flow from financing
 3. CASH FLOW STATEMENT

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• What Does A Cash Flow Statement Tell You?

– Cash is the fuel that runs your business. Running out of it would be
disastrous, so you must have a “cash flow” or money on hand to pay
bills and meet day-to-day expenses. Keep in mind that companies can
produce a profit, but still not have a positive cash flow.
– The Cash Flow Statement shows money that comes into the business,
money that goes out and money that is kept on hand to meet daily
expenses and emergencies.
 CASH FLOW STATEMENT
▪ The statement of cash flows integrates the information contained in the balance sheet and income statement
in a manner that allows an analyst to determine what the sources and uses of cash for a firm.
▪ The cash flow statement including:
1) Cash flow from Operating Activity: This section of the statement of cash flows lists the sources and uses of
cash that arise from the normal operations of a firm.

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 CASH FLOW STATEMENT
2) Cash flow from investing Activity: This section of the statement of cash flows lists the sources and
uses of cash that arise from the investing activities of a firm (generally related to long-term assets).
▪ Investing activities include:
▪ Borrowing or Repayment Debt
▪ buying and selling securities of other firms, and
▪ buying and selling property, plant, and equipment.

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 CASH FLOW STATEMENT
3) Cash flow from Financing Activity: This section of the statement of cash flows lists the sources and uses of
cash that arise from the financing activities of a firm (generally related to long-term liabilities and equity).
▪ Financing activities include:
▪ sales and repurchases of the firm’s equity,
▪ dividends to the firm’s stockholders, and
▪ issuances and retirements of the firm’s debt.

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 CASE 5 – CASH FLOW

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 INTERRELATION BETWEEN DIFFERENT STATEMENTS

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 INTERRELATION BETWEEN DIFFERENT STATEMENTS

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• The Relationship between Financial Statements: Articulation

the financial statements are not isolated items, they are closely
related and flow between each other to give a larger picture of
the business’ financial circumstances.
 INTERRELATION BETWEEN DIFFERENT STATEMENTS

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• Each statement can stand alone to offer a snapshot of the

given information. But separately, they do not allow an in
depth view of the whole financial state of the company.
Module three:
Financial Analysis