Short and long-term profit planning must include management plans for expansion or contraction of plant, buildings, equipment, machinery, major renovations, replacements, and other similar decisions that require significant resources.
investment-criteriaThese types of plans constitute the budget for capital disbursements that represent large commitments of funds and their impact on the company's progress extends over long periods.
Budgeting and management work starts from a strategic approach, starting with an analysis of the mission, vision and values of the organization, an analysis of the environment and an analysis of the sector to determine competitive advantages and disadvantages, then objectives, strategies can be defined and policies, activities are subsequently scheduled and resources are allocated according to a master budget and a capital outlay budget. An important aspect is management control to take the necessary corrections.
There were several reasons for senior management and middle managers to develop a capital outlay budget, as they face the problem of determining the amount of funds to invest, to maintain facilities adequately for growth, and to meet the demands of customers and competition. Adequate planning and control are also required to avoid idle operating capacity, overspending of operating capacity, and investment in assets that will produce a low return on invested funds.
This work includes aspects of policies and procedures, manuals and decision criteria to evaluate investment proposals of international firms from the 90s and 92s, so that for obvious reasons they are not mentioned in the development of the topic.
OBJECTIVES
- Distinguish the main aspects of the capital addition budget in a company. Know the type of decisions regarding investments, operations and financing that companies must make. Define the aspects for which capital investments are made. Understand the importance of planning and control of capital additions. Distinguish the role of controller and financial manager in capital expenditure budgets. Know the methodology for evaluating a project. Define the factors that are taken into account for the acquisition of machinery and equipment.. Analyze the decision criteria when evaluating an investment proposal in machinery or equipment
- THE BUDGET OF CAPITAL ADDITIONS
Management must develop a formal capital outlay budget, the important objectives of a capital expenditure or investment project budget are as follows:
- PLANNING
It allows planning, adequately displaying capital outlays.
1.2 COORDINATION
It allows to coordinate the capital disbursements in relation to:
- Financing needs - Cash needs. Investment committed to various operational activities. Sales Potential. Profit Potential. Return on investment potential.
1.3 CONTROL
It allows to control, supervise minor and major additions of capital expenditures.
Management faces a series of basic decisions in which we find the following:
1.4 INVESTMENT DECISIONS
1.4.1 CURRENT ASSETS:
- Customer inventories, etc.
1.4.2 FIXED ASSETS:
- Plant, Equipment, Machinery, Mines, Wells, Vehicles, Building, Land, Brands, Patents, etc.
1.4.3 OTHER ASSETS
- Long-term investments Organizational costs Improvements in third-party properties.
1.5 OPERATING DECISIONS
1.5.1 INCOME
- Operational for sale Non-operational (Various activities)
1.5.2 COSTS AND EXPENSES
- Cost of sales Administration expenses Sales expenses Financial expenses
1.5.3 UTILITY
- Gross margin Operating margin Net margin
1.6 FINANCING DECISIONS
1.6.1 CURRENT LIABILITIES
- Suppliers Short-term documents Bank credits Accumulated expenses payable
1.6.2 LONG-TERM LIABILITIES
- BondsMortgageFinancial obligations
1.6.3 EQUITY
- Capital contributions Additions Common shares Preference shares Retained earnings Donated surplus
The financing of an investment project (Capital Disbursement) can be with internal resources, external resources or mixed.
- REASONS TO MAKE CAPITAL INVESTMENTS
The rationale for making capital outlays is to improve and maintain the company's overall equity and responsibility (Value) over the long term.
Among the specific reasons for investment projects we have:
2.1 REDUCE CURRENT AND PROJECTED COSTS
- Labor Energy Transport Materials Reduce administrative expenses etc.
2.2 INCREASE SALES VOLUME
Increasing production capacity, either internally or externally by acquiring another company.
2.3 IMPROVE THE QUALITY OF PRODUCTS
Adding facilities that improve the product, reduce manufacturing defects, eliminate reprocessing, make it more durable, functional or practical and allow improvements in the design and / or production process.
2.4 PROTECT OR DEFEND THE CURRENT LEVELS OF SALES AND PROFITS
Adding new facilities or replacing existing ones to meet customer requirements and environment demands to stay competitive.
- THE INVESTMENT IN FIXED CAPITAL OF A COMPANY
The entrepreneur must choose the volume of productive factors with which he must operate (land, work, capital, technology) in view of its technical possibilities, its costs and the sale price.
The above implies several important decisions:
3.1 MAKE A PROPER ESTIMATE OF THE DEMAND LEVEL OF YOUR PRODUCTS
Directing a suitable price - production combination to the market.
3.2 CHOOSE THE AMOUNT OF OPTIMAL CAPITAL THAT YOU WILL HAVE TO COMPARE
With the productivity of capital and the costs of using it, the cost of using capital is what it costs the company to use capital for a certain period of time.
If the company has to request a loan to acquire a capital unit (Asset), the interest rate will be the first component of the cost. If a productive factor is needed in this, the asset is to maintain the level of productive efficiency. Fixed assets wear out or become depleted over time, we call this depreciation or depletion (mines - wells), therefore it is necessary to replace the worn out asset, here the expenses incurred by the type of interest and depreciation.
3.3 THE QUESTION OF HOW TO ELIMINATE THE DIFFERENCE BETWEEN THE DESIRED AND CURRENT CAPITAL
On the one hand, it implies greater demand for the industries that supply capital goods or delays in longer deliveries. On the other hand, the adaptation of new equipment is not usually a simple task, normally the process is complex. Rapid adaptation requires high costs, so the adjustment of capital requirements must take place gradually.
- ADMINISTRATIVE PLANNING OF CAPITAL DISBURSEMENTS (Investment Projects)
Capital disbursements imply the permanent commitment of large amounts of money, the decisions made have long-term effects and on the economic stability of the company. For this reason, careful analysis is necessary at the planning stage, an imprudent decision seriously affects the company, the lack of attention by senior management can result in excessive or insufficient investments and the deterioration of the competitive position.
4.1 THE DEVELOPMENT OF LONG-TERM GOALS
Requires tentative planning of necessary or desired capital additions and assessed cash position and finances. Long-term budgets have to be developed according to broad and tentative plans and policies, long-term plans have to be flexible and reduced to formal and written expressions. The plans are formalized in a profit plan and this defines to what extent managers are committed to carrying them out. Senior management faces two problems at this stage:
- Possible changes to capital additions already in progress. Capital disbursements to be included in the short-term profit plan.
Decisions about these two problems are essential to the capital outlay budget.
4.2 THE BUDGET OF CAPITAL DISBURSEMENTS
It should normally include two types of items, namely:
4.2.1 THE MAIN PROJECTS
Comprising considerable funds such as buildings, large machinery, and plant sites, this type of project involves construction and expenses for periods greater than one year. These types of projects are planned for several years before reaching a final decision.
4.2.2 MINOR CAPITAL PROJECTS
It includes minor additions that do not need to be planned in detail well in advance, it includes relatively low cost purchase of machinery and tools, small building renovations and various aspects related to operations. This type of capital outlay does not go into long-term plans.
- RESPONSIBILITY TO BUDGET CAPITAL DISBURSEMENTS
Policies and procedures should be established to stimulate ideas and proposals for capital additions. However, the responsibility for such proposals rests with all managers, including division and department supervisors.
For larger capital outlays the responsibility rests with senior management, for these proposals well-defined procedures should be established to ensure proper analysis and evaluation.
5.1 THE MAIN ASPECTS OF A CAPITAL DISBURSEMENT PROGRAM
- Generation of proposals Collection of data relevant to each proposal Evaluation of the proposal Selection of the two promising proposals and the allocation of project conditions to the selected ones Development of a budget for capital outlays Control of capital outlays Audits and evaluations to monitor actual results of capital additions
5.2 THE PROCEDURES ESTABLISHED FOR AN EXECUTIVE TO EXPRESS A PROPOSAL IN WRITING
- A description of the proposal Reasons for its recommendation Relevant data source Advantages and disadvantages of the proposal Recommended dates for its initiation and termination
5.3 THE SEQUENCE OF A PROPOSAL
It can be given in the following terms:
5.3.1 INITIAL PROPOSAL
Formulated by the operating or technical personnel of a department.
5.3.2 ANALYSIS OF MISCELLANEOUS ASPECTS
Operational, technological, legal, commercial and financial by the head of the department.
5.3.3 ANALYSIS AND RECOMMENDATIONS BY AN ADVISORY COMMITTEE
(Controller, Financial Manager, Treasurer, Statutory Auditor, Lawyer, Engineers, Department Heads).
In such an analysis, senior management may decide to abandon the project or continue with its analysis and planning.
Budget requests for minor capital additions should prevent managers from liability centers.
Affected executives and supervisors are responsible for estimating needs for their particular operation and subsequent control.
A chief engineer or financial executive must coordinate the development of the capital outlay budget.
5.4 THE CONTROLLER'S ROLE
In many companies, the controller is subordinate, the general manager being his co-pilot, and he has authority over the line executives, among his functions are budgets and planning, financial accounting, fiscal obligations to administrative control, internal audit, special studies, costs and safeguarding of assets. The comptroller defines the formats so that all projects are presented in the same way to facilitate their study and approval by the project committee, the board of directors or the general manager.
5.4.1 APPROVAL OF MINOR AMOUNT PROJECTS
It is recommended that these types of disbursements be held by the head of the area, in order to free the project committee and senior management of the study from those of little relevance. The company defines the minimum amount in pesos or dollars.
5.4.2 APPROVAL OF MAIN PROJECTS
For these larger capital expenditures, they must be approved by the project committee or the board of directors due to their importance to the future of the company.
5.5 THE ROLE OF THE FINANCIAL MANAGER
Its function is to promote the maximization of the value of the company in coordination with the other functional managers. Its function has to do with financial areas such as treasury, budgets, cost analysis, formulation and evaluation of projects and in general making decisions that have an impact in the short or long term and that affect the financial situation of the company.
5.6 AN EXAMPLE TO DELEGATE DECISION-MAKING AUTHORITY ON CAPITAL DISBURSEMENTS
| DISBURSEMENT AMOUNT | AUTHORITY MAKING THE DECISION |
| More than $ 200,000,000 | Board of Directors - Budget Committee |
| Between 100,000,000 - 200,000,000 | Executive President - Controller |
| Between 50,000,000 - 100,000,000 | General manager |
| Between 20,000,000 - 50,000,000 | The Financial Manager |
| Between 5,000,000 - 20,000,000 | The Division Manager |
| Less than 5,000,000 | Management Designated Person |
All of the above must be in accordance with the company's policies and procedures, complying with the aspects contemplated in points 5.1, 5.2, 5.3 and the methodology, analysis and evaluation of investment projects.
In the case of multinational companies the amount is determined in dollars or the currency of the country of the parent company and the organizational structure.
International Executive Director (Headquarters)
International Functional Director
Headquarters Advisor
Director General of Each Country
Functional Directors of Each Country
Direct from National Affiliates
Director of National Subsidiaries
- CONTROL OF CAPITAL DISBURSEMENTS
Control must rest on proper administrative planning that limits outlays on economically justifiable additions.
6.1 CONTROL OF MAJOR CAPITAL DISBURSEMENTS
It is necessary to have a central system that indicates to the managers the progress, cost and status of additions throughout the year.
6.1.1 THE FIRST ASPECT OF CONTROL
Includes the specific formal authorization to start the project, including the allocation of funds. Common practice is to give final approval on capital disbursement request forms.
6.1.2 THE SECOND PHASE OF THE CONTROL OF CAPITAL DISBURSEMENTS
It has to do with the accumulation of data on costs, work progress, accumulated disbursements.
A disbursement status report for each project should be prepared at short, weekly or monthly intervals.
6.1.3 THE PERIODIC CONTROL REPORT
Must contain:
6.1.3.1 COSTS
- Budgeted Amount Disbursements to date Pending Commitments Amount not disbursed according to Budget Estimated costs to complete the project Estimated Higher or Lower Disbursements to complete the project
6.1.3.2 PROGRESS REPORT
- Contains Start Date Initially scheduled completion date Estimated days needed to complete the project Estimated completion date Percentage completed to date in terms of time Percentage completed to date in terms of costs.
6.1.3.4 COMMENTS FOR HIGH MANAGEMENT
- Quality of work Unforeseen circumstances
6.1.4 MONITORING THE DISBURSEMENT PROCESS
After completing the project, cost records must be completed and the total cost must be recorded in the respective asset account, a final project report is delivered to senior management.
6.1.5 EXCESSIVE FUNDS
They should not be used to offset budget overruns on other projects without formal approval from senior management.
6.1.6 POST-PROJECT MONITORING
Some companies do regular studies after the completion of a major project to see if it is producing the expected results. This study allows verifying the sufficiency of the original analysis and having information for future decisions.
6.2 CONTROL OF MINOR CAPITAL DISBURSEMENTS
Minor capital additions are contemplated in an allocation for each responsibility center.
The manager of each center should have the authority to give final authorization for the specific disbursements he needs. You must have a cash level that you can authorize within a budget allocation.
6.2.1 ACCUMULATION OF REAL DISBURSEMENTS BY LIABILITY CONTRACT
Then two actual results are compared with the budgeted ones.
6.2.2 RESULTS REPORT BY EACH RESPONSIBILITY CENTER
You must indicate the variations and the undisbursed balances.
6.3 THE IMPORTANT PROJECT CONTROL MANUAL
Major projects should have a manual that is intended to provide the engineering, comptroller, accounting, and management departments with the information necessary to control project disbursements.
The manual represents a set of data relating to all individual investment projects. The manual should contain the following information.
- Investment Project Approved Request Budget for Control Updated Capital and Expense Status Reports Direct Costs, Overhead Costs and Start-Up Data for Each Application Financial Position Report Extract from weekly engineering notes Gantt Charts Outline of special methods to be used to control the execution of the projected investment
6.4 GENERAL ASPECTS FOR A GOOD CONTROL OF CAPITAL DISBURSEMENTS
- Capital Program Planning Calendar Authorization Calendar Printed Project Request Form Financial Assessment of Investment Projects Projected Investment Stages Sheet Capital Status and Expenditure Report Financial Position Report Condensed Monthly Report Quarterly Authorization Report Fund Recovery Status Report
- METHODOLOGY FOR THE ANALYSIS AND EVALUATION OF AN INVESTMENT PROJECT
7.1 DETERMINATION OF EACH OF THE INVESTMENT PROJECTS THAT HAVE
This involves determining the investment, the cash flows, the useful life of the project, the salvage value and all the qualitative information necessary for the analysis.
7.2 CALCULATE THE COST OF WEIGHTED CAPITAL
It consists of determining how much the company costs on average for each peso it handles. This is the minimum rate of return acceptable by the company, it is useful for the qualitative evaluation of the project.
7.3 QUANTITATIVE ANALYSIS
Each of the projects is analyzed using quantitative methods, a matrix is prepared that synthesizes each of the methods and allows projects to be selected according to their importance.
7.4 SELECTION OF PROJECTS
The performance it generates, the risk, the urgency and the need to carry it out are taken into account.
7.5 MONITORING OF PROJECTS
Once the project is selected, a control is made to monitor it and monitor that the expected benefits are being achieved as planned. Otherwise the necessary corrections are made.
- FACTORS TO BE TAKEN INTO ACCOUNT FOR THE ACQUISITION OF EQUIPMENT AND / OR MACHINERY
When the time comes to decide on the purchase of equipment and machinery, a number of factors that affect the choice must be taken into account, it is necessary to make a comparison of the different equipment and prepare the calculations that are necessary and useful in later stages.
The information that is necessary for this type of investment decisions are the following:
8.1 NECESSARY SUPPLIERS
For quotations, the prices of the goods are used for the initial investment, the specifications and dimensions are used for the distribution in the plant.
The capacity depends on the number of machines to be purchased to balance the lines, so that the materials and the process flow continuously.
8.2 THE LABOR
It is helpful to calculate the cost and level of training you need to have.
8.3 THE MAINTENANCE COSTS
They help us in calculating annual maintenance costs.
8.4 THE CONSUMPTION OF ELECTRIC ENERGY
It allows us to calculate the cost of this.
8.5 THE ADDITIONAL OR SPECIAL NEEDED INFRASTRUCTURE
It is required in certain cases such as high electrical voltage, it is necessary to provide it because it increases the value of the initial investment.
8.6 THE AUXILIARY EQUIPMENT FOR MACHINES
Conferring pressurized air, hot or cold water, equipment that needs air conditioning to provide this equipment is out of the main price, investment and space requirements are increased.
8.7 THE COST OF FREIGHT AND INSURANCE
Check if they are included in the original price or if they must be paid separately and how much they amount.
8.8 THE COSTS OF INSTALLATION AND START-UP
Check if they are included or not in the original cost and how much it is.
8.9 EXISTENCE OF REFRACTIONS IN THE COUNTRY
Especially for advanced technology equipment whose refractions can only be obtained imported, if there are problems obtaining or importing currency, so the equipment can be stopped in case of failure. It is necessary to provide this situation.
- FACTORS TO BE TAKEN INTO ACCOUNT WHEN SIGNING DECISIONS TO APPROVE CAPITAL DISBURSEMENTS
9.1 EMERGENCIES
The urgency of operational needs can impede extensive analyzes, search for sources of supplies, etc., for example if an equipment is damaged or breaks and is practically irreparable, the progress of operations stops with loss of time, costs, delays or non-compliance. to the clients, therefore the urgency forces to choose the equipment to the machine that they give us first.
9.2 REPAIRS
Availability of spare parts and maintenance experts is key. That is why foreign equipment is often discarded as a practical option in the face of repair problems or specialized service centers.
9.3 CREDIT
Some providers are generous in terms compared to others, this is a determining factor for many companies.
9.4 NON-ECONOMIC CONSIDERATIONS
Social considerations regarding local suppliers and non-economic preferences.
9.5 VALUE OF INVESTMENT
9.5.1 ADDITIONS OF MINOR CAPITAL
They are not discussed in great detail as they are necessary in ongoing operations, they comprise varied and necessary details of the centers of responsibility. They are better planned, evaluated and controlled through open assignments for cost control.
9.5.2 THE MAJOR CAPITAL ADDITIONS
They demand special analysis, administrative evaluation, and judgment. Your financial evaluation should be undone in the decision-making process.
Among the approaches for its evaluation are the following:
- Refund or recovery method Average rate of return methods
Average return on investment
Average return on average investment
- Discounted cash flow methods
Net present value
Internal rate of return
1.5.3 EXAMPLE TO EVALUATE AN INVESTMENT IN MACHINERY
Machinery worth $ 110,000 needs to be purchased as a capital addition to a men's shoe manufacturing process.
The estimated information is as follows:
Machine cost US $ 110,000
Useful life 10 years
Average Annual Income US $ 86,770
Average Annual Expenses 20,385
Depreciation 110,000
Annual Expenses 30,000
Tax 35%
SOLUTION
CASH INCOME
Sales 86,770
- Costs 30,000
- Expenses 20,385
- Depreciation 11,000
_________
Income Before Tax 25,385
- Tax 8,885
_________
Net Income 16,500
+ Depreciation 11,000
__________
Cash Income 27,500
27,500 00 27,500 27,500 27,500 27,500 27,500 27,500 00 27,500 27,500 27,500
$ 110,000
9.5.3.1 BY THE METHOD OF REFUND OR RECOVERY
Investment disbursement
RA = __________________________
Annual Cash Income
110,000
RA = __________________________ = 4 Years
27,500
This method does not take into account the value of money over time, nor does it distinguish between alternatives that have different economic lives.
This method is useful when:
- Accuracy is not crucial A large number of proposals have to be made preliminarily Cash and credit are critical Risk is high or future potentials are difficult to calculate after the payback period Helps assess liquidity, the faster the investment recovers, the less the company's liquidity suffers Gives an idea of the magnitude of the risk the longer the period the greater the risk and vice versa
9.5.3.2 BY THE AVERAGE RETURN METHOD OF INVESTMENT
Annual Income or Cost Savings
RPI = _________________________________
Net Investment Disbursement
27,500
RPI = __________
110,000
This method has the same disadvantages as the recovery or refund period.
9.5.3.3 BY THE AVERAGE RETURN METHOD OF INVESTMENT
Annual Cash Income or cost savings
RA = ________________________________________
Net Investment Disbursement / 2
27,500
RA = __________________________ = 0.5 = 50%
110,000 / 2
This method assumes that each annual cash income recovers a proportional part of the investment and exaggerates the rate of return.
It has the same disadvantages as the previous ones.
9.5.3.4 BY THE DISCOUNTED CASH FLOW METHOD
- n
1 - (i + 1)
VP = A -------
i
-10
1 - (1.09)
PV = 27,500 -------- - 110,000
0.09
PV = 176,486 - 110,000 = 66,486
In this case, it is convenient to make the investment in machinery because the VP is greater than zero (POSITIVE), generating US $ 66,486 that could be distributed among the shareholders if they approve the project and it starts up.
This method has as advantages that it takes into account the value of money over time, when selecting a project the one that gives the highest net present value is chosen, but it is required to know the discount rate or cost of capital for its evaluation.
9.5.3.5 BY THE METHOD OF THE INTERNAL RATE OF RETURN
It consists of finding a rate that applied to future income will make the discounted sum equal to expenses, that is, the NPV is equal to zero
Since it cannot be calculated directly, it must be determined by trial and error.
NPV (10%) = 58,975
NPV (21%) = 14,871
VPN (22%) = - 211.24
The IRR is between 21% and 22%
| FEES | VPN | % | ADJUSTMENT | TIR |
| twenty-one% | 1487.1 | 87.57 | 0.8757 | 21.87% |
| 22% | -211.24 | 12.43 | 0.1243 | 21.87% |
| one% | 1698.34 | 100% | one |
In this case, the investment project in machinery generates an IRR of 21.87%, which is to assume the opportunity cost of 9%, therefore the project must be carried out.
9.6 EXAMPLE FOR THE PURCHASE OF EQUIPMENT BY THE EQUIVALENT ANNUAL COST METHOD
Powder packaging contractor company performs manual process costing $ 170,000,000 per year including materials, wages, benefits and indirect costs
To modernize and upgrade to the new technologies and competitiveness of the sector, you have the following alternatives
- Acquire a dosed equipment for packaging for $ 300,000,000 that causes fixed costs $ 65,000,000, but also must pay $ 35,000,000 annually for consumption of electrical energy, maintenance and insurance. Salvage value is not contemplated. Acquire an automated equipment for $ 500,000,000 that causes annual costs and expenses of $ 70,000,000, which growing at a rate of $ 6,000,000 annually, the salvage value is $ 80,000. 000.
The useful life of both teams is 10 years and the opportunity rate is 15%
Which alternative is more advisable for this company?
SOLUTION
Currently expressed in thousands
PROPOSAL 1 EXPRESSED IN THOUSANDS
170,000 170,000 170,000 170,000 170,000 170,000 170,000 170,000 170,000 170,000
CAE = 170,000 Equivalent Annual Cost
PROPOSAL 1 EXPRESSED IN THOUSANDS
100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000
300,000
i = 0. 15
0.15
CAE = 300,000 -------- + 100.
-10
1 - (1.15)
CAE = 159,775
PROPOSAL 2 EXPRESSED IN THOUSANDS
80,000
70000 76000 82000 88000 94000 100000 106000 112000 118000 124000
500,000
0.15 10
CAE = 500,000 ------ + 70,000 + 6000 1 / 0.15 - 10 / (1.15) -1
-10
1 - (1.15)
0.15
- 80,000 -------
10
- - one
CAE = 99,626 + 89,168 - 3940 = 184,854
CAE = 184,854
SUMMARY OF ALTERNATIVES
| PROPOSAL | FALLS OFF |
| Current | 170000 |
| Project 1 | 159775 |
| project 2 | 184854 |
The best investment for this company is project 1 because its CAE of 159,775 is less than the other alternatives.
The equivalent annual cost method consists of distributing the investment cost in the different years that the project lasts, each year the CAE is compared with the positive flow generated by the project.
If we have an investment project that costs $ 600,000,000 and the flows that it will generate during the 4 years of its useful life are $ 300,000,000. Evaluate the project by the CAE if the discount rate is 30%.
SOLUTION EXPRESSED IN THOUSANDS
CAECAECAECAE
600,000 = ------ + ------ + ------ + -----
(1.3) (1.3) (1.3) (1.3)
600,000
CAE = --------------------
(1.3) + (1.3) + (1.3) + (1.3)
600,000
CAE = -------- = 276,924
2,166
Comparison with positive project flows
300,000 - 276,924 = 23,076
Therefore the project pays for itself.
CONCLUSIONS
- Capital presentation is a process of evaluating and selecting investments that help maximize the benefit of the owners of a business organization. By making decisions to invest in current assets, fixed assets or other assets, it is possible to reduce costs, increase sales volumes, improve product quality and defend or increase the company's profit levels. Capital is conceived as an interrelation of stages like this:
- PRESENTATION OF PLANS OR PROJECTS: Capital expenditures by people of different levels of the organization to achieve a flow of ideas resulting in cost savings, increased productivity and taking advantage of opportunities in the environment. DISBURSEMENT ANALYSIS: Capital They are made to determine the suitability in accordance with the overall objectives of the company and evaluate its rentabilidad.LA DECISIONS oF CAPITAL EXPENDITURES tO dETERMINE tHE AMOUNT yOUR ORGANIZATION iN tHE dECISION mAKING LEVEL :Generally, the board of directors or the board of directors approves projects that require significant disbursements, while smaller projects are delegated to lower levels. REVIEW OR CONTROL: It is done in the application stage, reviewing the results in the operations phase, the comparison of real costs and benefits with those expected is of vital importance to make adjustments; reduce costs, increase benefits and make the necessary changes.
- The evaluation of an investment proposal is best done with methods that take into account the value of money in time, such as the VPN, the CAE and the IRR. Methods such as payback period and return on investment are more countable and do not take into account the value of money over time.
ACQUISITION OF COMPANIES
OBJECTIVES
- Know the way a company is negotiated Analyze the procedures used to determine the value of a company Distinguish the ways companies combine for their growth Determine the procedure to follow before buying a company Know the aspects to investigate before acquiring a firm Distinguish the forms of growth of an organization
INTRODUCTION
A company internally grows by expanding its assets or its sales force by increasing its sales force either with its current and new products in its current markets and new products in its current markets or conquering others.
The external growth of a company occurs through the partial or total acquisition of other companies in progress and that give it a strategic advantage, at this stage an assessment of the company is required to make an informed decision.
To value a company there are different methodologies and the main ones are:
- Book value Adjusted book value Replacement value Market value Price / profit ratio Value based on comparable transactions Present value of profit flow Present value of cash flow Present value of free cash flow
External growth occurs by three schemes:
- CONSOLIDATIONS: When two companies come together to create one, example Burrough and Sperry to create UNISYS, Comfenalco Palmira and Comnindustria to create Comfaunion. MERGERS: When one company acquires another, and merges it, the acquirer continues and the acquired one disappears as an independent company, for example Banco Santander and Comercial Antioqueño and Banco de Bogotá with Banco del Comercio. GROWTH BY CONGLOMERADOS: Part of one or several companies, participating in the share capital of each one of them, an example of which is the Ardila Lule group, the Santodomingo Group, the Antioqueño Union, the Aral Group.
In the case of mergers, there are synergistic effects in terms of economy of scale and complementation, vertical integration strategies (markets), suppliers or horizontal integration strategies are given by greater control of the market and complement of activities, we also found tax benefits, better liquidity and financial structure and power motivations.
In the case of conglomerates, there is a pyramidation of capital (Parent, Subsidiary and Subsidiary). The group central is carried out by the parent through 2 or 3 and these control the rest of the companies and diversify the risk of investments.
CRITERIA FOR VALUING A COMPANY
HOW MUCH IS A COMPANY WORTH?
- THE FIRST SITUATION IS TO CALCULATE THE VALUE OF ITS ASSETS AND LIABILITIES, EQUITY OR ITS INTRINSIC VALUE
This method is a terrible estimate of what the company would be worth for the following aspects.
- A company may have equipment of great value in pesos, but in the face of a technological innovation that renders them obsolete, they lose commercial value, such is the case of computers, software, laboratory equipment, machinery, and generally assets that relate to technology. state-of-the-art such as those of iron and steel, publishing houses, sugar mills, measurement laboratories, telephony, diagnostic aid in medicine. Foreign competition and the innovations generated by globalization, make them not very competitive. Limitation in the supply of raw materials used due to an environmental control regulation that restricts their use or limits their exploitation. The figures shown in accounting are historical. and inflation overwhelms them. If these are adjusted to take into account the effect of inflation and examined,the ability of the company to generate cash as the sole determinant of its value, this bad measure for the value of its net assets, an example of this is the North American steel mills were worth little compared to the Japanese because they exceed them in technology, the factories of Telex were left behind in front of easy machines, traditional encyclopedias and books have a serious threat against those who come on CD and those who can download online.traditional encyclopedias and books have a serious threat against those that come on CD and those that can be downloaded online.traditional encyclopedias and books have a serious threat against those that come on CD and those that can be downloaded online.
Let's see an example with the balance of an industrial company
Cia. Industrial SA
BALANCE SHEET
As of December 31 In thousands of $
| ASSETS | 2001 | 2002 | ||||
| Current Assets | ||||||
| Available | 480000 | 450000 | ||||
| Temporary Investments | 240000 | 210000 | ||||
| customers | 1200000 | 990000 | ||||
| Inventories | 1566000 | 2493000 | ||||
| Total Current Assets | 3486000 | 4149000 | ||||
| Property, Plant and Equipment | ||||||
| Ground | 1000000 | 1000000 | ||||
| Buildings | 4000000 | 4100000 | ||||
| Machinery and equipment | 2000000 | 2500000 | ||||
| Computer and Communication Team | 1550000 | 500000 | ||||
| Total Property and Plant | 8550000 | 8100000 | ||||
| Total Assets | 12036000 | 12049000 | ||||
| PASSIVE | ||||||
| Current Liabilities | ||||||
| Financial obligations | 480000 | 390000 | ||||
| Providers | 1470000 | 1710000 | ||||
| Total Current Liabilities | 1950000 | 2100000 | ||||
| Long-term liabilities | ||||||
| Consolidated layoffs | 180000 | 150000 | ||||
| Bonds Payable (2005) | 4800000 | 4500000 | ||||
| Total Long-Term Liabilities | 4980000 | 4650000 | ||||
| Total Liabilities | 6930000 | 6750000 | ||||
| HERITAGE | ||||||
| Actions | 2000000 | 2000000 | ||||
| Utilities Retention | 3106000 | 3299000 | ||||
| Total assets | 5106000 | 5299000 | ||||
| Passive and heritage | 12036000 | 12249000 | ||||
| EQUITY = ASSETS - LIABILITIES | ||||||
| 2001 | 5106000 = 12036000 - 6930000 | |||||
| 2002 | 5499000 = 12249000 - 6750000 | |||||
If we wanted to buy this company we could not say that in 2001 it was worth $ 5,106,000 and in 2002 $ 5,499,000 for its intrinsic value for the following reasons:
- We do not know how their machinery and equipment worth $ 2,000,000 and $ 2,500,000 million are technologically, as well as their communication equipment worth $ 1,550,000 and $ 500,000 million. We also do not know what degree of modernism and what type The structure of the building has. The balance does not show the inflation adjustments of the assets that require adjustment to show more real figures. Given the portfolio and inventories we do not know how clean they are, is the entire portfolio likely? How many bad debts? there are? There are obsolete inventories We do not know what environmental restrictions regarding the use of raw materials the company has or if it uses non-renewable raw materials (Exhaustable) that do not allow its continuity in the medium or long term. We do not know how the company is in its industrial sector,If it is a leader in its market or what position it occupies or how it is compared to its foreign competitors, if there are barriers to entry or exit or what bargaining power its customers or suppliers have, suppose that the company obtained a profit of $ 193,000,000 in 2002 for the sales of 3 products (A $ 4,000,000,000, B $ 3,000,000,000 and C $ 2,200,000,000) that were reflected in the increase in equity. As far as the value of the heritage influences the future of the company. Another aspect is the life cycle of each of its products, we do not know if products A, B and C are in their introduction stage (due to their sales figures already passed it), growth, maturity and obsolescence, to determine if investing in this process is convenient.If there are barriers to entry or exit or what bargaining power your customers or suppliers have, suppose that the company obtained a profit of $ 193,000,000 in 2002 for sales of 3 products (A $ 4,000,000,000, B $ 3,000.000,000 and C $ 2,200,000,000) that were reflected in the increase in equity. As far as the value of the heritage influences the future of the company. Another aspect is the life cycle of each of its products, we do not know if products A, B and C are in their introduction stage (due to their sales figures already passed it), growth, maturity and obsolescence, to determine if investing in this process is convenient.If there are barriers to entry or exit or what bargaining power your customers or suppliers have, suppose that the company obtained a profit of $ 193,000,000 in 2002 for sales of 3 products (A $ 4,000,000,000, B $ 3,000.000,000 and C $ 2,200,000,000) that were reflected in the increase in equity. As far as the value of the heritage influences the future of the company. Another aspect is the life cycle of each of its products, we do not know if products A, B and C are in their introduction stage (due to their sales figures already passed it), growth, maturity and obsolescence, to determine if investing in this process is convenient.000) that were reflected in the increase in equity. As far as the value of the heritage influences the future of the company. Another aspect is the life cycle of each of its products, we do not know if products A, B and C are in their introduction stage (due to their sales figures already passed it), growth, maturity and obsolescence, to determine if investing in this process is convenient.000) that were reflected in the increase in equity. As far as the value of the heritage influences the future of the company. Another aspect is the life cycle of each of its products, we do not know if products A, B and C are in their introduction stage (due to their sales figures already passed it), growth, maturity and obsolescence, to determine if investing in this process is convenient.
- MARKET VALUE IS ANOTHER WAY TO MEASURE HOW MUCH A COMPANY IS WORTH.
The stock exchanges perceive the value of the shares, through information from press publications, specialized magazines, financial reports. In many underdeveloped countries, the stock exchanges do not make a complete valuation of the companies, because they manipulate the valuation of the shares for tax purposes.
If we look at the stock price on May 30, 2002 we find:
| Price | Price | Variation | Price | Price | ||
| Business | Previous | Closing | $ | $ | Maximum | Minimum |
| Tobacco | 2570 | 2548 | -22 | 0.86 | 2550 | 2547 |
| Bancolombia | 1500 | 1520 | twenty | 1.33 | 1520 | 1505 |
| Bavaria securities | 183 | 182 | -one | -0.55 | 185 | 182 |
| Success | 3350 | 3350 | xxx | xxx | 3350 | 3301 |
| GUARANTEE | 150 | 150 | xxx | xxx | 150 | 147 |
| Weaver | 74.9 | 74.9 | xxx | xxx | 74.9 | 74.9 |
If we wanted to invest, we would need to know the earnings of each of these companies, their earnings per share (EPS), the degree of financial leverage and the aspects of the environment that cause the share price to fluctuate in the market.
- THE MEASUREMENT OF THE PRICE / PROFIT RATIO
This method fixed at the value of the share as a multiple of its dividends, is used in the United States is called the pricelearning ratio (P / E) and fluctuates capriciously between 7 and 16, this method ignores if during the period investments were made that They will influence higher profits during the following period, in addition to the variability of the multiples.
A similar, but more logical measure is obtained by the equation VA = (D / i) + g
Where VA = share value
D = Estimated dividends
I = VPN discount rate
G = growth rate
With this method, the accounting measurement of profit applies discount methods, assuming that dividends are invariably repeated at porpetvity and are divided by a discount rate obtained from the present value of the uniform series. It also measures the expectation of growth in the share price based on its historical behavior.
This method recognizes that the profit of the action is given by the dividends received and by the appreciation that the security value achieves over time in the market.
Accounting is a photograph where the film of the past is exposed, but what interests us is also the future, for this reason accounting is discredited for not adapting to the handle of inflationary situations, its figures can be manipulated and adapted without violating accounting principles Generally accepted, for these aspects described above, the measurement of the flow of funds has taken a lot of strength, since it allows us to look at where the company is going and play (Simulate) with its parameters, analyzing its impact on the generation of funds.
The Shareholder Valuation Analysis (SVA) allows to analyze the result of any strategy on the added value to the sum invested by the shareholders. This technique has been used to evaluate investments, they are the same discount techniques, net present value, internal rate of return, discounted flows, etc., it is being used to measure the company as a whole, to replace equipment.
The value of a company is the sum of its debt plus the value that it represents for its shareholders, therefore the value of the shareholders is the value of the company minus its debt. The value of the company is made up of the present value of its operating cash flow plus the residual value plus the assets that it currently owns that can be liquidated without effecting the firm's operating capacity.
The flow of operating funds represents the sum to compensate shareholders and creditors. Ser must be discounted at present value with the capital cost rate (weighted average cost of the cost of debt and the expected return by shareholders.
The flow of funds is the difference between income and expenses. It does not include financial costs. It is calculated after taxes. The necessary capital investments must be taken into account. Increases of working capital are also included. It is considered that sales are received according to the portfolio term and that the raw material is acquired before production. It is convenient to express the flows in current terms (at least for the period analyzed). You have to be consistent with the discount rate, expressing it in current terms
The cost of capital takes into account the cost of the liabilities after taxes. The minimum acceptable rate depends on many factors, there will be a minimum rate below what the shareholders will not do business, this rate has to be higher than the rate that institutional savings pay without risk (otherwise people would save and not invest). Shareholders expect different loans from different businesses with higher expectations at different risks, the level of indebtedness is another risk factor that increases the aspirations of shareholders.
Beta is the percentage difference between the expected minimum rate and the rate that the investment could obtain without risk
- POLICIES AND BENEFITS OF ACQUIRING BUSINESSES
When buying another company, what is sought is to increase the profitable power, usually in the long term with a view to increasing earnings per share (EPS). Acquisition policies should focus on certain types of potential operations. Reducing alternatives saves a lot of time and can avoid many mistakes.
A procurement policy must take into account:
- Similarities to current operations Similarities of techniques and administrative objectives Potential of profits Magnitude of the acquisition program Determination of the desired rate of return.
- EVALUATION OF POTENTIAL ACQUISITIONS
Evaluation is a very important stage in making decisions, continuing negotiations, and setting the prices to be paid. The most important aspects of the evaluation are:
- Forecast of the future market Analysis of fixed and variable costs Assessment of the position of the company to carry out these approaches. IN FINANCIAL ASPECTS
MUST BE EVALUATED
- Profit in the product line Industry cyclical Seasonal sales Differences between the industrial branch between who buys and who sells Cash flow budget Valuation of fixed assets Audit reviews Review of labor contracts IN MANAGEMENT CAPACITY
If you plan to keep current managers, you need to value the staff that you have or will have
Will the executives of the acquired firm adapt to the guidelines of the company that buys?
Is there capacity to adapt to the expansion plans that were implemented?
Is nepotism widespread?
What incentive changes will need to be made after the acquisition?
Are there second-level managers who with training can occupy higher levels?
It is important to have ready management successors.
- IN MARKET ASPECTS
Analyzing product lines, geographical areas, it is important to carry out market research to determine volumes and prices, analyze the life cycle of identical products and evaluate competition.
- NECESSARY INVESTIGATIONS
It is necessary to have several investigations before closing the deal, among them we have:
- External Audit Title research Sufficiency of insurance coverage Urban area regulation Availability of land, squares and conditions External leases, terms and conditions Long-term contracts, terms and conditions Applicants and registered trademarks and pending applications to be resolved Pending litigation with their possible results Property rights over actions
- EXAMPLE ON THE VALUE OF A COMPANY
- GENERAL ASPECTS OF THE NEGOTIATION
A group of investors receives an offer for a company in the following terms:
- Sellers aim for $ 2.8 billion}
The company being sold is low risk
- The units budgeted to sell next year are 000 to $ 1000 C / EU The increase in units to sell is 100,000 per year for the next 5 years and will stabilize. Prices will increase by 25% per year in line with inflation. Sales are collected with one month deadline, there are no arrears in the portfolio. Purchases are worth 50% of sales and gross margin is 50%. One month of inventories is required and suppliers give 30 days of deadline. is in a straight line, the book value of buildings is $ 250 million, machinery $ 600 million, buildings depreciate in 20 years, the rest in 10 years. The income tax rate is 30% The Labor is $ 100 million in the first year with increases of 26% per year.Administrative expenses are $ 50 million annually and other expenses (various) $ 20 million and both will increase with the inflation index. From the third year it is necessary to make equipment replacements worth $ 30 million, for research and $ 10 million a year is earmarked for development. The increase is with the inflation index. In liabilities there is a development loan recently received worth $ 475 million at 30% on balances with a term of 3 years and one year dead. If additional credit is required, this is achieved at 35%. The company has an uncommitted asset in production in which the cash surpluses of $ 200 million are invested and the remaining 45% is subtracted, this value increases according to inflation.It is estimated that at the time of the sale the box will have $ 100 million as the minimum cash balance for its operations, for the following year it is $ 125 million and it is updated with inflation. The rest of the cash generated can be distributed.ASPECTS TO TAKE INTO ACCOUNT IN THE VALORIZATION
Value of the contribution of the partners is equal
Value of the company in the period analyzed
+ Your residual value
+ Commercial value of non-committed assets in production
- Commercial value of credits. VALUE OF THE COMPANY IN THE PERIOD ANALYZED A period of 5 years to the flow of funds is analyzed. Year 6 is studied for a better calculation of the residual value. WHAT CONTAINS THE CASH FLOW
The physical evolution of the production of the prices of the income and the costs of raw materials, the collections by concept of portfolio of the previous year, raise a month and the current year 11 months.
The expenditure for the purchase of raw material is calculated, considering the policy of one month of inventory and that the supplier grants a 30-day term.
The depreciations that are required when calculating taxes are included.
The second part of the cash flow begins with the operating flow; Income is payments for raw materials, labor, administrative expenses, and other expenses. Interest is not taken because the model evaluates the company as if it were all its own (without debt)
6.2.3 DISCOUNT OF CASH FLOW
We discount the cash flow distributions to the cost of capital of the company as follows:
- The company aspires to maintain a structure
With own funds 50%
With liabilities 50%
- The commercial credit is 35% Taxes of 30% 35% x 77% = 24.5% The desired rate by investors wants 45% after tax
The cost of capital (Opportunity)
It looks like this:
| Before | After | |||
| Source | Tax | Tax | Participation | Weighted |
| Debt | 35% | 24.50% | fifty% | 12.25% |
| Input | 64.86% | 45.00% | fifty% | 22.50% |
| 34.75% |
DISCOUNTED FLOW AT 5 YEARS
205 355 457 631 874
VPN = ---- + ---- + ---– + ---– + ----–
13475 (13475) (13475) (13475) (13475)
NPV = 152.14 + 195.51 + 186.77 + 191.39 + 196.73
VPN = 922.54
6.2.7 THE RESIDUAL VALUE
The company can last for many years (No 5 as it is done in the evaluation of the distribution flow) because additional investments will be made in years 3, 4, 5 and 6 for replacement of equipment, in addition to spending on research and development from year 1 to 6 to guarantee their survival, their profitability.
From year 6 onwards sales do not increase (stabilize) and will be in the stage of the maturity life cycle and will remain stable due to market competition, therefore the distribution flows are considered the same from year 6 onwards, having a uniform flow. This flow is discounted with the cost of capital, transforming it in constant terms.
1 + current rate = (1 + constant rate) + (1 + rate for inflation)
1 + current rate
constant rate = -------------- - 1
1 + inflation rate
1 + 03475
constant rate = -------– - 1
1 + 0.25
13475
tc = ------ - 1 = 0.078 = 7.8% Annual
1.25
Present value of residual flow in year 6
1,114
VP = ----- = 14,282.05
0.078
Present value in year 1 of residual flow
14,282.05
VP = ----- = 3214.75
(1.3475)
6.2.8 COMMERCIAL VALUE OF DEBT
The interest rate 30% on balances and the term 3 years, there is a dead year
| YEAR 0 | YEAR 1 | YEAR 2 | YEAR 3 | YEAR 4 | |
| Credit | 475.00 | ||||
| Balance payable | 158.33 | 158.33 | 158.33 | ||
| Capital subscription | 475.00 | 475.0 | 316.67 | 158.33 | |
| Interests | 142.50 | 142.5 | 95.00 | 47.50 | |
| Tax Deduction | 42.75 | 42.75 | 28.50 | 14.25 | |
| Full payment | 99.75 | 258.08 | 224.83 | 191.58 |
The market cost of this debt is discounted to VPN, taking as a discount rate, the one charged by the bank to sell the portfolio, we take 32% as the portfolio discount rate and we bring to NPV of year zero.
99.75 258.08 224.83 191.58
VPN = ---- + ---- + ---- + ----
1.32 (1.32) (1.32) (1.32)
NPV = 75.57 + 148.12 + 97.76 + 63.10
VPN = 384.55
6.2.8 COMPANY VALUE
| Discounted Flow Present Value | 922.54 | |
| Residual value | 3,214.75 | |
| Non-Productive Assets | 200 | |
| Commercial Value of Debt | -384.55 | |
| TOTAL | 3,952.74 |
| BALANCE | ||||
| CURRENT ACTIVE | PASSIVE | |||
| Available | 100 | Development Credit | 475 | |
| FIXED ASSETS | HERITAGE | |||
| Building | 250 | Contributions - Actions | 475 | |
| Machinery | 600 | |||
| LIABILITIES + EQUITY | 950 | |||
| TOTAL ASSETS | 950 | |||
DECISION ANALYSIS
The company is worth 3,952.74 million
Its intrinsic value 475.00 million
Value requested by sellers 2,800 million
The company is worth more than its owners ask for
The difference between the 2 estimated values is 1,152.74 million, therefore it is convenient for potential buyers to make a sensitivity analysis to estimate the behavior in the face of variations in:
- Sales, Prices, Costs Profit Margins, Taxes Portfolio Turnover and Inventories Fixed Costs Analyze Similar Transactions Stock Market Value
CONCLUSIONS
- A company has a different strategic value for different investors, for some it is synergy, for others it is independent business, a business is good today and bad tomorrow and vice versa. To acquire a business, you must make a comprehensive assessment of its intrinsic value, value of your actions in the market, cash flow analysis and sensitivity analysis to have a broad vision before making the decision. Before acquiring a company, you must evaluate market aspects, financial aspects, managerial capacity, and previous necessary research. When buying a company, they include audits, legal investigations, legal regulations, contracts, insurance, patents and pending litigation. People play a very important role in two acquisitions, because the company is people,many acquisitions have failed to change people or when they retire because they are dissatisfied with the new employers and their policies.
BIBLIOGRAPHY
- ARBOLEDA V German Projects, formulation, evaluation and control. Ediciones Toro, Cali 1985BACA URBINA Gabriel Project evaluation. Third edition. Editorial Mc Graw Hill MéxicoBURBANO E Jorge Presupuesto Modern approach to planning and control of resources. Second edition. Editorial Mc Graw HillCONTRERA Marco Elias. Formulation and evaluation of projects. UNISUR, Bogotá 1997GUTIERREZ Luis Fernando. Finances for developing countries. Editorial norma, Cali 1992WELSH Glen. Budgets, planning and control of profits, PHI Bogotá 1981 editorial SATIZABAL GARCIA Diego Fernando. Foundations of financial mathematics and economic engineering.
