Corporate

Entrepreneurship:
Entrepreneurial Accounting
and Finance

Lectured by Mr Ncemane
Index
1. Recap of Week One
2. Groups and Class Leader
3. Week Two Academic Programme – Lecture Content
Recap of Week One
In week one we looked at:
• Business Models and How they interlink with accounting and finance.
• Understanding how to read Financial Statements.
• Segmentation (revenue, direct costs and gross profit)
• Cost Allocation (between direct and indirect costs)
• Financial Analysis
• Using Financial Analysis for Financial Compliance
Groups and Class Leader
Thank you for completing the online form. The Class Leader is Valentine Maroga
Group 1 Group 2
Aubrey Ngobeni Betty Mahlangu
Dikeledi Pertunia Magagula Chuene Mohlaba
Gugu Khalishwayo Khethiwe Simelane
Melford Meletla Mduduzi Khanyile
Suzan Lekhuleni Nkosana Khoza Group 3
Valentine Maroga Samuel Bhebe Aaron Maringa
Khosi Grootboom
Nkgalabi Seleka
Nomvula Phasha
Group 3 Group 4 Sheila Moloko
Lebogang Mkhabela Clement Masemola Vuyo Valashiya
Lungile Maluleke Dikeledi Magagula
Mamonare Chueu Kgole Jerry
Nkgalabi Seleka Mojalefa Radebe
Nokuphila Ndzinisa Mosima Moloto
Paul Sungula Sanna Baloyi
Zinhle Simelane
Current Asset Management
and Short-Term Financing

Focus Topic:
Cash Budget through Cash
Management
Current Asset Management
Remember from Week One when we went through the “How to Read Financial
Statements” component of the class.
The Statement of Financial Position contains Assets, which are divided into two:
• Non-Current Assets, and
• Current Assets.

Focus now is on the management of current assets as they form part of the:
• Working Capital Turnover Rate,
• Inventory Turnover Rate,
• Debtors Days, and
• Current Ratio.
Current Asset Management
Current Asset Management is concerned with:
• Credit Policy.
• How it is set/formulated
• 5 Cs of Credit

• Various impacts on/of having a credit policy.

• ACCOUNT RECEIVABLE MANAGEMENT

• Accounts Receivable = credit sales per day * collection period

• INVENTORY MANAGEMENT
• Inventory Models: Economic Order Quantity (EOQ) formula.
• Inventory Control Systems
• Just-In-Time Inventory Management
Current Asset Management
CASH MANAGEMENT:
Unutilized cash reserved have an opportunity cost. Cash should be used to generate
more revenue.

Why do organisations hold cash? 4 main reasons:

• Transactions
• Precautionary reasons
• Speculation
• Loan covenants.

Class Example 12.5

Current Asset Management – Cash
Management: Cash Inflows
Current Asset Management – Cash
Management: Cash Inflows
Current Asset Management – Cash
Management: Cash Outflows
Current Asset Management – Cash
Management: Cash Outflows
Current Asset Management – Cash
Management: Cash Outflows
Current Asset Management – Cash
Management: Cash Budget
Current Asset Management – Cash
Management: Cash Budget
Current Asset Management – Notable
Things
Things to note from this example:
• Growth in sales.
• Decline in cash flow.
• Negative cash lowers the current ratio.

Remember Financial Analysis from Week One where the TREND ANALYSIS principles
were:
• Growth in sales is always good if its rate is much higher than that of any growth in
costs.
• When sales grow, an organisation must attempt to arrest costs or where growth in
costs is unavoidable, costs to grow at a much lower rate than that of revenue.
• In financial analysis we did the working capital turnover rate ratio and the current
ratio. The example has an impact on these.
Current Asset Management – What
Impacts Cash Budgets
• Credit policies of organisation
• Early settlement discounts
• Too long payment dates/plans even when interest in charged
• Weak collection plans

• Lack of demand for organisation’s products

• Resulting in longer inventory holding periods
• Which then result in high holding cost

• Pleasing creditors
• Paying cash
• Settling early
• Inability to bargain (read about Porters’ Five Forces in your spare time)

• Financing operations with credit/loans

Forecasting
Looks into the future, however not all information is available.
How do organisation forecast
• Annualization (amount *12/n period)
• Using publicly available data (inflation, various pricing rates/instruments, statistics
etc.)
• Using private information (agreements, deal profiles, investor roadshows etc.)
Capital Budgeting

Part 1:
Chapter 8
Introduction
Capital budgeting is the is the process of identifying, evaluating, and implementing a
firm’s investment opportunities.

Capital budgeting enables the analysis and evaluation of investment projects that
normally produce benefits over a number of years.

Capital budgeting offers a competitive advantage in that it seeks to identify investment

that will enhance a firm’s competitive advantage and increase shareholder wealth.

The typical capital budgeting decision involves a large up-front investment followed by a
series of smaller cash inflows.

Poor capital budgeting decisions can ultimately result in company bankruptcy.

Types of Investment Projects
• Replacing old/worn out or obsolete assets
• Improving business efficiencies
• Expansion through new asset acquisition for new markets
• Business combination and/or mergers and acquisitions
• Complying with statutory requirements (buying spectrum)
• Fulfilling work-force demands
• Fulfilling environmental requirements.
Independent vs Mutually Exclusive Projects
INDEPENDENT PROJECTS
• Acceptance of one project does not affect the acceptance of another.

MUTUALLY EXCLUSIVE PROJECTS

• Are alternatives.
• Either one or the other can be accepted.
• Not both

NB FOR GROUP ASSIGNMENT - NEEDS TO BE INCORPORATED

NB FOR EXAM AS EITHER OF THESE TYPES OF PROJECTS MAY BE USED TO
EXAMINE YOUR UNDERSTANDING OF THE PRINCIPLES.
Divisible vs Indivisible Projects
DIVISIBLE PROJECTS
• Can be split into a number of separate parts.
• Each part capable of being undertake on its own.

INDIVISIBLE PROJECTS
• Undertaken at once as full project.
• Can either be independent or mutually exclusive.

NB FOR GROUP ASSIGNMENT - NEEDS TO BE INCORPORATED

NB FOR EXAM AS EITHER OF THESE TYPES OF PROJECTS MAY BE USED TO
EXAMINE YOUR UNDERSTANDING OF THE PRINCIPLES.
The Basics of Capital
Budgeting.

How cash flows!

Categories of Cash Flows
• Initial Cash Flows, are cash flows resulting initially from the project. These are typically
outflows.

• Operating Cash Flows, are the cash flows generated by the project during its operation.
These cash flows are typically positive cash flows.

• Terminal Cash Flows, result from the disposition (sale) of the project/asset. These are
typically positive cash flows.
Major Cash Flow Components
Conventional Cash Flows
Nonconventional Cash Flows
Relevant Cash Flows
INCREMENTAL CASH FLOWS
• Cash flows specifically associated with the investment
• Their effect on the firms other investments must be considered.
For example, if a day-care center decides to open another facility, the impact of
customers who decide to move from one facility to the new facility must be considered.

EXPANSION versus REPLACEMENT CASH FLOWS

• Estimating incremental cash flows is straight forward in the case of expansion
projects, but not so in the case of replacement projects.
• With replacement projects, incremental cash flows must be computed by subtracting
existing project cash flows from those expected from the new project.
Relevant Cash Flows
SUNK COSTS versus OPPORTUNITY COSTS
• Cash outlays already made are sunk costs.
• Sunk costs are irrelevant to the decision-making process.

• Opportunity costs, are cash flows that could be realized from the best alternative use
of the asset, are relevant.
Relevant Cash Flows - Examples
• Cash inflows, outflows, and opportunity costs.
• Changes in working capital.
• Installation, removal and training costs.
• Depreciation
• Existing asset effects on cash flows
Capital Budgeting
Techniques
Capital Budgeting Techniques
Important to know the following techniques as they have their own ways of being
calculated:

Non-Discounting Techniques:
• Payback Method
• Accounting Rate of Return

Non-Discounting Techniques:
• Net Present Value (NPV) Method
• Internal Rate of Return (IRR) Method
• Economic Value Added (EVA)
Capital Budgeting
Techniques

Non-Discounting
Techniques
Non-Discounting Techniques: Payback
Period
This method calculates how long it takes a project to generate enough cash inflows to
recoup the initial outlays.

The time taken to repay the initial outlays is term the 'payback period'.

The longer the payback period, the longer cash is tied up in the project and the greater
the risk

The decision rule is to accept the project with the shortest payback period.

Focus in on determining “n”.

Non-Discounting Techniques: Payback
Period
EXAMPLE:
Example 1 – page 8-8
Example 2
Tshiamiso Design and Hydraulics is planning to buy a machine. The initial cost is R 40
000 and the net cash inflows expected from the machine are as follows:
Year Expected cash inflows
1 R 10 000
2 R 14 000
3 R 12 000
4 R 12 000
5 R 10 000
Calculate the payback period.
Non-Discounting Techniques: Payback
Period
EXAMPLE:
Example 2 Calculation and Solution:

Year Expected cash inflows Payback Period

0 R 40 000 R0
1 R 10 000 R 10 000
2 R 14 000 R 24 000
3 R 12 000 R 36 000
4 R 12 000 payback during (but before the end of) the 4th year
5 R 10 000 = 3.25 (3+(R4k/R12k))
Non-Discounting Techniques: Accounting
Rate of Return (ARR)
The Accounting Rate of Return (ARR) method calculates the return from a project using
• the average net profit after tax divided by the average investment.
• The decision rule is to accept a project with the highest return on investment (ROI).

Focus in on determining “ a rate”.

Formula: ARR = Average Incremental Net Income

Average book value

• The average book value if the residual value is zero, will be Cost
• Net income is after depreciation.
Non-Discounting Techniques: Accounting
Rate of Return (ARR)
Example:
Thinkers Afrika is considering the acquisition of machinery which will considerably
reduce labour costs.

The machine costs R 20 000 and will have no residue value after four years.

Year Estimated net profits before depreciation

1 8,000 8 000
2 8,000 16 000
3 8,000 24 000
4 4,000 28 000
Non-Discounting Techniques: Accounting
Rate of Return (ARR)
Example:
Thinkers Afrika is considering the acquisition of machinery which will considerably
reduce labour costs. The machine costs R 20 000 and will have no residue value after
four years.
Depreciation is R = R 5 000 (which is R 20 000/4 years)

Year Estimated net profits after depreciation

1 R 3,000 R 3 000
2 R 3,000 R 6 000
3 R 3,000 R 9 000
4 -R1,000 R 8 000 therefore ARR = R 2000 / R 10 000 = 20%
R 2 000 = R 8 000/4 years)
R 10 000 = R20 000/2 because the machine has a zero residual value.
Capital Budgeting
Techniques

Discounting
Techniques
Exam Topics
Discounting Techniques: Net Present Value
(NPV) Method
NPV involves the following:
• Forecasting the project inflows.
• Determining a suitable discount rate.
• Calculating the present values of the components.
• Calculating the net present values of the components.
• Accepting all projects with a positive NPV.

use a timeline to depict such a project.

• The annual net cash flows are calculated as profit after interest and tax, minus cash
outflows and depreciation.
• The initial investment plus the annual net cash flows are cash inflows minus cash outflows.
• The life of the project is in periods of years.
• The terminal cash flow is the expected net cash flow after tax, such as the sale of assets or
recovery of working capital.
Discounting Techniques: Net Present Value
(NPV) Method
Timeline indicating the initial investment, operating cash flows and the terminal cash
flow.
Discounting Techniques: Net Present Value
(NPV) Method
The NPV formular is as follows:

NPV = Present value of net cash flows – initial investment

• The critical NPV project decisions are as follows:

• Accept projects with a positive NPV.

• Projects with an NPV of zero make no contribution and should be rejected.
Discounting Techniques: Net Present Value
(NPV) Method
Class Example:
The Brainwave Medical Group, is considering expanding by opening a new site for its BW
Dialysis Clinics company. The required medical equipment will cost R450 000 and
increase patient capacity while reducing costs.

Year Net inflows Discount rate 10 % Present value

1 150 000
2 200 000
3 250 000

Minus initial investment

Net present value
Discounting Techniques: Net Present Value
(NPV) Method
Class Example Solution:
For the discount rate see Table C on page T-6 or on the formula sheet provided via
myTutor on page 9 of Table C
Year Net inflows Discount rate 10 % Present value
1 150 000 0,9091 136 365
2 200 000 0,8264 165 280
3 250 000 0,7513 187 825
Total 489 470
Minus initial investment 450 000
Net present value 39 470
Discounting Techniques: Internal Rate of
Return (IRR)
• The Internal Rate of Return (IRR) is also known as the 'marginal efficiency of capital'.
• It is defined as the discount rate which causes project NPV to be exactly zero
• The rate of interest that equates the cash outflows of a project to the present value of
future cash inflows.
• The decision rule is to accept the project with a higher IRR compared to the cost of
capital.
• The higher the IRR the more attractive the project.
• The IRR is calculated by the trial-and-error method.
• Try to choose a rate that will give a positive NPV close to zero and another rate that
will give a negative NPV close to zero.
Discounting Techniques: Internal Rate of
Return (IRR)
Class Example:

Synergy Architects is considering buying a new architectural printing machine which

requires a net investment outlay of R 6000. The machine will have a life span of five
years and the estimated net cash savings are given below:

End of the year Project cash savings

1 R 1000
2 R 2000
3 R 3000
4 R 4000
5 R 4000
The desired minimum rate of return is 10%. Compute the IRR.
Discounting Techniques: Internal Rate
of Return (IRR)
Class Example:
Using the present value (PV) table we can deduce the following
Period 5% 10% 15% 20% 25%
Period Cash Saving 5% 10% 15% 20% 25%
1 0.952 0.909 0.87 0.833 0.8
1 R1 000 952 909 870 833 800
2 R2 000 1 814 1 653 1 512 1 389 1 280
2 0.907 0.826 0.756 0.694 0.64 3 R3 000 2 591 2 254 1 973 1 736 1 536
4 R4 000 3 291 2 732 2 287 1 929 1 638
3 0.864 0.751 0.658 0.579 0.512 5 R4 000 3 134 2 484 1 989 1 608 1 311

4 0.823 0.683 0.572 0.482 0.41 Total 11 783 10 031 8 630 7 495 6 565
Net Investment - 6 000 - 6 000 -6 000 -6 000 -6 000
NPV 5 783 4 031 2 630 1 495 565
5 0.784 0.621 0.497 0.402 0.328
Discounting Techniques: Economic Value
Added (EVA)
• How much will a project earn each year if we deduct the capital charges from the income?
EVA = Net operating profit after tax - (Invested Capital x Cost of Capital)
• Accounting earnings include revenue and expenses but does not include cost of capital

Class Example:
A company raises equity finance to the value of R100m

The sales revenue less expenses = R8m in the first year.

The cost of capital to the company is 15%

What is the EVA?

Discounting Techniques: Economic Value
Added (EVA)
Class Example Solution:

EVA = Net operating profit after tax - (Invested Capital x Cost of Capital)

EVA = 8m - (15%x R100m)

= -R7m

The EVA is negative meaning the company is actually incurring a loss.

Capital Budgeting

Tax Effects
Tax Effects - Introduction
Taxation is a major expense for most organisation. It is important to determine the effect
that a project will have on the firm’s tax charge.

After tax cash flows need to be considered

• Cost of project = full cash outflow to start the project
• What about depreciation?
Use of tax allowances as provided for by SARS
Cost * Tax Allowance Rate * Tax Rate
• Sale of existing equipment?
Recoupments and scrapping allowance
Capital Gains Tax (inclusion rates and tax rates)
• Working capital requirements?
Use incremental working capital
Capital Budgeting

Rules to apply when

faced with an exercise.
Capital Budgeting Rules
• Only include Incremental cash flows
• Use future after-tax cash flows
• Ignore Sunk costs
• Include Opportunity costs - foregone cash flows
• Include the negative and positive effects of new product lines on existing lines
• Evaluate all alternatives
• Ignore all Allocated costs
• Ignore Financing charges, this would amount to double counting.
• Working capital
• Evaluate working capital changes, not levels
• Separate accounting from cash flows
• Separate the financing from the investment decisions
Things to remember:
This lecture has a significant impact on your assignments.

Lots of exam topics contained in week 2 and 3.

Buy the text book

Spend time on myTutor for content and updates

A financial calculator will simplify your life, however there are

formulas provided.
Thank You