Foundations of Management 2

Week 7:
Financial Performance Measurement
1) Financial Ratios: Return on Investment
2) Social Return on Investment

Dr. Yally Avrahampour

Associate Professor (Education)

26th February 2024

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 Part 1)

Introduction

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 Outline of Today’s Lecture
1) Introduction
- Analysing the financial ratios of Rafael & Fernando (R&F Enterprises case), week 2
2) Financial Ratios:
- Return on capital employed
- Decomposing Return on Capital Employed into ratios of margin and efficiency
- Return on equity
- Decomposing Return on Equity into ratios of margin, efficiency and leverage
- Working Capital and liquidity ratios
- Investment ratios
3) Social Accounting: Social Return on Investment
- Rationale
- Steps in Calculating SROI : 1) Identifying stakeholders,
- 2) Mapping outcomes,
- 3) Evidencing outcomes and assigning them a value
- 4) Monetizing goods or services without a price,
- 5) Establishing impact
4) Summary of Lecture
5) Appendices
6) Seminars: a) Financial Policy at Apple, b) SROI at Dalmia Bharat Cement

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 Foundations of Management 2: Sessions
Week 1: Making Business Decisions that Commit Capital
Reporting
Week 2: Representing a Firm’s Financial Condition: 1 To users of
Accounts
Week 3: Representing a Firm’s Financial Condition: 2

Week 4: Operations Management and Inventory Management Measuring

and
Managing
Week 5: Valuing and Managing Costs
Costs

Week 7: Financial Ratios and Social Return on Investment

Measuring
Performance
Week 8: Balanced Scorecard and Economic Value Added

Week 9: Occupations, Professions and Expertise Management

and the
setting of
Week 10: Individual and Institutional Investors In a Historical Context
standards
relating to
Week 11: Organization and Management Theory governance.
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 Financial Ratios
• Financial ratios develop a profile of the financial
performance of a business by comparing two or
more figures in the financial statements.

• Financial ratios are most useful when used

comparatively
• Past periods for the same business
• Businesses in same sector
• Relative to a target

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 Part 2)

Financial Ratios:
Return on Investment

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 Return on Investment (ROI)
• Return on Investment is a generic term for ratios
focusing on the return on an investment.

• We will focus on two such ratios:

– Return on Capital Employed
– Return on Equity

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 Return on Capital Employed (ROCE)

Return on Capital Employed =

Operating Profit / Capital Employed

Capital Employed = Shareholders Equity +

Long term debt + Short term debt

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 Return on Capital Employed
• Measures the return that the firm has earned
on the capital raised from all investors.
– Is an ‘Entity’ or ‘Enterprise’ level measure of return.
– Includes all investors in the firm.
– Long term and short term debt measures include
only debt raised as financing and not in the course
of conducting business.
• Two tests of whether liabilities are for purpose of
financing or operations:
1. Is the debt interest bearing? (Rules out most trade
creditors. But what about zero coupon bonds?)
2. Motive: does the liability arise in conjunction with
another transaction conducted in the course of
business?
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 Calculating Capital Employed using R&F
Enterprises Balance Sheet
Assets (£)
Plant, Property & Equipment 250,000
Inventories 20,000
Trade Debtors (Receivables) 66,000
Pre-paid Expenses 20,000
Cash 290,000
Total Assets 646,000

Liabilities
Trade Creditors (Payables) 75,000
Non-current Liabilities 50,000
Total Liabilities 125,000

Shareholders’ Equity
Share Capital 500,000
Retained Profit 21,000
Total Equity 521,000

Total Liabilities & Equity 646,000

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 1) Operating Profit
and 2) Earnings Before Interest & Tax (EBIT)

• Capital employed comprises the investment

made by shareholders and debt holders.
• Consequently, when calculating Return on
Capital Employed, the profit figure used is
Operating Profit (otherwise Earnings Before
Interest & Tax).
– Earnings before debt-holders and shareholders
have received any distributions by way of interest
or dividends.

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 Operating Profit from R&F Enterprises
Income Statement

(£)
Revenue 171,000
Cost of Goods Sold - 135,000
Operating Profit 36,000
Interest Expense - 5,000
Net Profit 31,000

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 R&F Enterprises Ratios
Return on Capital Employed (ROCE) Current ratio
Capital Employed 571,000 Current assets 396,000
Operating Profit 36,000 Current liabilities 75,000
ROCE 6.30% Current ratio 5.3

Decomposing ROCE Acid test

ROCE 6.3% Current assets minus Inventories 376,000
Operating Profit / Revenue 21.1% Current liabilities 75,000
Revenue / Capital Employed 29.9% Acid test 5.0

Return on Equity (ROE) Trade Debtor Period

Equity 521,000 Trade Debtors (Receivables) 66,000
Net Income 31,000 Revenue 171,000
ROE 5.95% Trade Debtor Period in number of days 141

Decomposing ROE Inventory Holding Period

Net Profit / Revenue 18.1% Opening inventory 0
Revenue / Assets 26.5% Closing inventory 20,000
Assets / Equity 124.0% Average inventory 10,000
Cost of goods sold 135,000
Interest Cover Inventory Holding Period in number of days 27
Operating Profit 36,000
Interest Received - Trade Creditor Period
Interest Payable 5,000 Trade Creditors (Payables) 75,000
Interest Cover -7.2 Cost of goods sold 135,000
Opening inventory 0
Closing inventory 20,000
Purchases 155,000
Trade Creditor Period in number of days 177

Working capital cycle

Trade Debtor Period 141
Inventory Holding Period 27
Trade Creditor Period 177
Working capital cycle in number of days -9
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 Decomposing Return on Capital
Employed

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 The Profitability Equation
• An advantage of both Return on Capital Employed (ROCE) and
of Return on Equity (ROE) is that these ratios decompose into
more specific ratios enabling analysis of the drivers of
profitability.

ROCE = Operating Profit / Capital Employed

ROCE = Operating Profit / Revenue x Revenue / Capital Employed

ROCE = Margin x Efficiency

• Return on Capital Employed is decomposed into margin and

efficiency
– Margin measures the difference between the prices at which the firm sells its
product and the cost of production
– Efficiency measures how well the firm utilizes the capital it has raised (or its
assets) to generate sales.

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Decomposing Return on Capital Employed

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 Profitability ratios (Margins)
• Different ratios relating to margins assess the relationship between revenue
and different types of expense incurred by the firm in conducting its
business.

• Gross margin focuses on the cost of making goods ready for sale, before
any sales, general and administrative or depreciation expenses.

Gross margin = Gross Profit / Revenue

• Operating margin focuses on profit from trading but before interest and
taxes.

Operating margin = Operating Profit / Revenue

• Net margin examines the profit after financing costs and taxes.

Net margin = Net Profit / Revenue

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 Calculating Operating Margin to
Decompose ROCE Using the R&F
Enterprises Income Statement
(£)
Revenue 171,000
Cost of Goods Sold - 135,000
Operating Profit 36,000
Interest Expense - 5,000
Net Profit 31,000

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 Calculating the Efficiency Ratio to
Decompose ROCE Using a) the R&F
Enterprises Income Statement

(£)
Revenue 171,000
Cost of Goods Sold - 135,000
Operating Profit 36,000
Interest Expense - 5,000
Net Profit 31,000

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Calculating the Efficiency Ratio to Decompose ROCE
Using b) the R&F Enterprises Balance Sheet
Assets (£)
Plant, Property & Equipment 250,000
Inventories 20,000
Trade Debtors (Receivables) 66,000
Pre-paid Expenses 20,000
Cash 290,000
Total Assets 646,000

Liabilities
Trade Creditors (Payables) 75,000
Non-current Liabilities 50,000
Total Liabilities 125,000

Shareholders’ Equity
Share Capital 500,000
Retained Profit 21,000
Total Equity 521,000

Total Liabilities & Equity 646,000

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 R&F Enterprises Ratios
Return on Capital Employed (ROCE) Current ratio
Capital Employed 571,000 Current assets 396,000
Operating Profit 36,000 Current liabilities 75,000
ROCE 6.30% Current ratio 5.3

Decomposing ROCE Acid test

ROCE 6.3% Current assets minus Inventories 376,000
Operating Profit / Revenue 21.1% Current liabilities 75,000
Revenue / Capital Employed 29.9% Acid test 5.0

Return on Equity (ROE) Trade Debtor Period

Equity 521,000 Trade Debtors (Receivables) 66,000
Net Profit 31,000 Revenue 171,000
ROE 5.95% Trade Debtor Period in number of days 141

Decomposing ROE Inventory Holding Period

Net Profit / Revenue 18.1% Opening inventory 0
Revenue / Assets 26.5% Closing inventory 20,000
Assets / Equity 124.0% Average inventory 10,000
Cost of goods sold 135,000
Interest Cover Inventory Holding Period in number of days 27
Operating Profit 36,000
Interest Received - Trade Creditor Period
Interest Payable 5,000 Trade Creditors (Payables) 75,000
Interest Cover -7.2 Cost of goods sold 135,000
Opening inventory 0
Closing inventory 20,000
Purchases 155,000
Trade Creditor Period in number of days 177

Working capital cycle

Trade Debtor Period 141
Inventory Holding Period 27
Trade Creditor Period 177
Working capital cycle in number of days -9
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 Return on Equity

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 Return on Equity
• Return on Equity (ROE) = Net Profit /
Shareholders’ Equity
• Measures the return on the capital provided by
the firm’s shareholders only.
– The net profit figure reflects the profits payable to
equity shareholders in the form of dividends.
• It comes after payment of interest and taxes (note the
difference with the profit figure used in calculating
ROCE).

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 Calculating Shareholders’ Equity
from the Balance Sheet
Assets (£)
Plant, Property & Equipment 250,000
Inventories 20,000
Trade Debtors (Receivables) 66,000
Pre-paid Expenses 20,000
Cash 290,000
Total Assets 646,000

Liabilities
Trade Creditors (Payables) 75,000
Non-current Liabilities 50,000
Total Liabilities 125,000

Shareholders’ Equity
Share Capital 500,000
Retained Profit 21,000
Total Equity 521,000

Total Liabilities & Equity 646,000

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 Calculating Net Profit from the R&F
Enterprises Income Statement

(£)
Revenue 171,000
Cost of Goods Sold - 135,000
Operating Profit 36,000
Interest Expense - 5,000
Net Profit 31,000

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 R&F Enterprises Ratios
Return on Capital Employed (ROCE) Current ratio
Capital Employed 571,000 Current assets 396,000
Operating Profit 36,000 Current liabilities 75,000
ROCE 6.30% Current ratio 5.3

Decomposing ROCE Acid test

ROCE 6.3% Current assets minus Inventories 376,000
Operating Profit / Revenue 21.1% Current liabilities 75,000
Revenue / Capital Employed 29.9% Acid test 5.0

Return on Equity (ROE) Trade Debtor Period

Equity 521,000 Trade Debtors (Receivables) 66,000
Net Profit 31,000 Revenue 171,000
ROE 5.95% Trade Debtor Period in number of days 141

Decomposing ROE Inventory Holding Period

Net Profit / Revenue 18.1% Opening inventory 0
Revenue / Assets 26.5% Closing inventory 20,000
Assets / Equity 124.0% Average inventory 10,000
Cost of goods sold 135,000
Interest Cover Inventory Holding Period in number of days 27
Operating Profit 36,000
Interest Received - Trade Creditor Period
Interest Payable 5,000 Trade Creditors (Payables) 75,000
Interest Cover -7.2 Cost of goods sold 135,000
Opening inventory 0
Closing inventory 20,000
Purchases 155,000
Trade Creditor Period in number of days 177

Working capital cycle

Trade Debtor Period 141
Inventory Holding Period 27
Trade Creditor Period 177
Working capital cycle in number of days -9
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 Decomposing Return on Equity

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 Decomposing Return on Equity
• Similarly to Return on Capital Employed Return (ROCE),
Return on Equity (ROE) can also be decomposed into more
specific ratios.
ROE = Net Profit / Shareholders’ Equity

= Net Profit / Revenue x Revenue / Assets x Assets / Equity

= Margin x Efficiency x Leverage (“Du Pont Analysis”)

• Return on Equity is decomposed into margin, efficiency and

leverage
– Margin measures the proportion of revenue is kept as net profit.
– Efficiency measures how well the firm utilizes its assets.
– Leverage measures how much assets the firm controls given the
equity it has raised from shareholders.
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 Calculating Net Margin to Decompose
ROE Using the R&F Enterprises Income
Statement
(£)
Revenue 171,000
Cost of Goods Sold - 135,000
Operating Profit 36,000
Interest Expense - 5,000
Net Profit 31,000

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 Efficiency Ratios
• The asset turnover ratio examines how well a company uses its
total assets to generate revenue. Weetman (2019) notes that this
ratio is best considered over a number of years.

Asset turnover ratio = Revenue / Assets

• The fixed assets turnover ratio measures how well a company uses
its fixed (non-current) assets to generate revenue.

Fixed asset turnover ratio = Revenue / Fixed assets

• The fixed asset turnover ratio concentrates on the productive

capacity of the firm, including the usage of the plant, property and
equipment to generate sales.

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 Calculating the Efficiency Ratio to
Decompose ROE Using a) the R&F
Enterprises Income Statement
(£)
Revenue 171,000
Cost of Goods Sold - 135,000
Operating Profit 36,000
Interest Expense - 5,000
Net Profit 31,000

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Calculating the Efficiency Ratio to Decompose ROE
Using b) the R&F Enterprises Balance Sheet
Assets (£)
Plant, Property & Equipment 250,000
Inventories 20,000
Trade Debtors (Receivables) 66,000
Pre-paid Expenses 20,000
Cash 290,000
Total Assets 646,000

Liabilities
Trade Creditors (Payables) 75,000
Non-current Liabilities 50,000
Total Liabilities 125,000

Shareholders’ Equity
Share Capital 500,000
Retained Profit 21,000
Total Equity 521,000

Total Liabilities & Equity 646,000

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 Leverage Ratios
• Capital structure: A fundamental financing decision.
– How much of the assets should be funded by equity or debt?

• The degree to which a firm is debt financed is called

‘leverage’’. Leverage can be measured in different ways:
– As a proportion of assets controlled by the firm.

Leverage = Assets / Shareholders’ Equity

• Or in direct relationship to equity.

Debt to Equity ratio = Net Debt / Shareholders Equity

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 Calculating the Leverage Ratio to
Decompose ROE using the R&F Enterprises
Assets Balance Sheet (£)
Plant, Property & Equipment 250,000
Inventories 20,000
Trade Debtors (Receivables) 66,000
Pre-paid Expenses 20,000
Cash 290,000
Total Assets 646,000

Liabilities
Trade Creditors (Payables) 75,000
Non-current Liabilities 50,000
Total Liabilities 125,000

Shareholders’ Equity
Share Capital 500,000
Retained Profit 21,000
Total Equity 521,000

Total Liabilities & Equity 646,000

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 R&F Enterprises Ratios
Return on Capital Employed (ROCE) Current ratio
Capital Employed 571,000 Current assets 396,000
Operating Profit 36,000 Current liabilities 75,000
ROCE 6.30% Current ratio 5.3

Decomposing ROCE Acid test

ROCE 6.3% Current assets minus Inventories 376,000
Operating Profit / Revenue 21.1% Current liabilities 75,000
Revenue / Capital Employed 29.9% Acid test 5.0

Return on Equity (ROE) Trade Debtor Period

Equity 521,000 Trade Debtors (Receivables) 66,000
Net Profit 31,000 Revenue 171,000
ROE 5.95% Trade Debtor Period in number of days 141

Decomposing ROE Inventory Holding Period

Net Profit / Revenue 18.1% Opening inventory 0
Revenue / Assets 26.5% Closing inventory 20,000
Assets / Equity 124.0% Average inventory 10,000
Cost of goods sold 135,000
Interest Cover Inventory Holding Period in number of days 27
Operating Profit 36,000
Interest Received - Trade Creditor Period
Interest Payable 5,000 Trade Creditors (Payables) 75,000
Interest Cover -7.2 Cost of goods sold 135,000
Opening inventory 0
Closing inventory 20,000
Purchases 155,000
Trade Creditor Period in number of days 177

Working capital cycle

Trade Debtor Period 141
Inventory Holding Period 27
Trade Creditor Period 177
Working capital cycle in number of days -9
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 Part 3)

Working Capital

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 Working Capital and Liquidity ratios
• “Working capital is the amount which a business must provide to finance
the current assets of a business, to the extent that these are not covered
by current liabilities.” (Weetman 2019:255).
• An increase in working capital increases the firm’s need for cash.

• Liquidity ratios measure the ability of a firm to meet its most immediate
liabilities from liquid assets.

Current ratio = Current assets / Current liabilities

• The acid test excludes inventories, the least liquid current asset, from the
determination of assets.

Acid test = (Current assets – Inventory) / Current Liabilities

• In an emergency situation it may be that the firm needs liquidity

exceptionally quickly. Hence the acid test.
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 Liquidity ratios
• The stock holding period ratio (inventories holding period) measures the
average period during which inventories are held before being sold or
used as inputs in the next stage of production.

Inventory holding period: Average inventory / cost of goods sold x 365

Inventory turnover ratio = Cost of goods sold / average inventory

• The trade debtor collection period ratio measures the pace at which the
firm converts sales into cash.

Trade debtor collection period: trade debtors / revenue x 365

• The trade creditor payment period ratio measures the pace at which the
firm pays cash for purchases from its suppliers.

Trade creditor payment period: trade creditors / purchases x 365

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 Working Capital (“Cash Conversion”) Cycle
• The working capital cycle of a business is the sequence of
transactions and events involving current assets and current
liabilities, through which the business makes a profit (Weetman
2019:254)

Working capital cycle = Inventory holding period +

Trade debtor collection period –
Trade creditor payment period.

• Working capital represents the long-term finance needed to cover

current assets that are not matched by current liabilities. The
longer the total of inventory holding period and the customer
collection period minus the trade creditor payment period, the
greater the need for working capital to be financed long term
(Weetman 2019:263-264)
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 R&F Enterprises Balance Sheet
Assets (£)
Plant, Property & Equipment 250,000
Inventories 20,000
Trade Debtors (Receivables) 66,000
Pre-paid Expenses 20,000
Cash 290,000
Total Assets 646,000

Liabilities
Trade Creditors (Payables) 75,000
Non-current Liabilities 50,000
Total Liabilities 125,000

Shareholders’ Equity
Share Capital 500,000
Retained Profit 21,000
Total Equity 521,000

Total Liabilities & Equity 646,000

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 R&F Enterprises Ratios
Return on Capital Employed (ROCE) Current ratio
Capital Employed 571,000 Current assets 396,000
Operating Profit 36,000 Current liabilities 75,000
ROCE 6.30% Current ratio 5.3

Decomposing ROCE Acid test

ROCE 6.3% Current assets minus Inventories 376,000
Operating Profit / Revenue 21.1% Current liabilities 75,000
Revenue / Capital Employed 29.9% Acid test 5.0

Return on Equity (ROE) Trade Debtor Period

Equity 521,000 Trade Debtors (Receivables) 66,000
Net Income 31,000 Revenue 171,000
ROE 5.95% Trade Debtor Period in number of days 141

Decomposing ROE Inventory Holding Period

Net Income / Revenue 18.1% Opening inventory 0
Revenue / Assets 26.5% Closing inventory 20,000
Assets / Equity 124.0% Average inventory 10,000
Cost of goods sold 135,000
Interest Cover Inventory Holding Period in number of days 27
Operating Profit 36,000
Interest Received - Trade Creditor Period
Interest Payable 5,000 Trade Creditors (Payables) 75,000
Interest Cover -7.2 Cost of goods sold 135,000
Opening inventory 0
Closing inventory 20,000
Purchases 155,000
Trade Creditor Period in number of days 177

Working capital cycle

Trade Debtor Period 141
Inventory Holding Period 27
Trade Creditor Period 177
Working capital cycle in number of days -9
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 Investment Ratios

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 Investment ratios
Investment ratios focus on the merits of the firm as an investment.

Earnings per share = Earnings after preference dividends / No. of shares

The P/E ratio may be interpreted as the number of years that the currently
reported profits would take to cover the stock price.

Price Earnings ratio (“P/E ratio”) = Stock price / Earnings per share

The dividend yield ratio measures the income paid by the share.

Dividend yield = Dividend per share / Market price per share

The dividend cover ratio assesses the firm’s ability to maintain its dividend.

Dividend cover = Earnings per share / Dividend per share

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 Limitations of Ratio Analysis
1) Historical relationships may not continue, there is a need for forecasting and
this is done best by understanding the causal processes that contribute to the
financial outcomes.

2) Data largely related to historical cost accounting information. Consequently:

a) Intangible assets are omitted from consideration (week 2).
b) The focus on historical cost information suggests that market values should
replace the historical cost information provided in accounts (week 3)

3) There is typically no consideration of the cost of capital (see weeks 1 and 8).

4) Year-end or quarterly data. Include more up-to-date accounting information?

5) Companies may not be comparable.

6) Other information necessary to do more detailed investigation.

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 Part 4)

Social Return on Investment

(SROI)

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 Social Return on Investment
• Financial value of social impact only: “Social Return on Investment
(SROI) is a framework for measuring and accounting for [a] concept
of value; … The basic idea is to calculate the financial value of the
investment and the financial value of the social costs and benefits.
This results in two numbers – and there are several different ways
of reporting on the relationship between these numbers.” UK Office
of the 3rd Sector (2010)
• Measuring the financial value of social impact, one is using SROI to measure
the performance of a Not-For-Profit Social Enterprise.
• Example: Wheels to Meals. (Pages 102-110 in the Guide to SROI), Dalmia Cement.

• “Social Return on Investment (SROI) … describes the social impact

of a business or non-profit’s operations in dollar terms, relative to
the investment required to create that impact and exclusive of its
financial return to investors... ” (Lingane & Olsen 2004:117, 119).
• Measuring the performance of a For-Profit Social Enterprise

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 Five Stages in Determining Impact
• Stage 1: Establishing scope and identifying key stakeholders.
• Establishing clear boundaries about what the analysis will cover and who will be
involved in the process and how.
• Stakeholders are “people or organizations that experience change or affect the activity, whether
positive or negative, as a result of the activity being analysed.”

• Stage 2: Mapping outcomes.

• An impact map: the relationships between the inputs, outputs and outcomes.
• Inputs are a measure of what stakeholders contribute in order to make an activity possible. The
financial value of the inputs are the investment.
• The inputs can themselves be financial or can be converted into financial metrics, for example,
the time of volunteers, donations of goods and services.
• Outputs are a quantitative summary of an activity. “For example, the activity is provision of
training and the output is “we trained 50 people to NVQ level 3”.
• The precise relationship between the inputs and the outcomes depends upon
the specific theory of change explaining how the intervention contributes to
change in the world more generally.
• Engaging with the stakeholders, so that we have clarity about what the SROI
analysis will cover and who will be involved in the process.

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 Five Stages in Determining Impact
• Stage 3: Evidencing outcomes and assigning them a value
• Developing outcome indicators.
• Outcome refers to the consequences to society of a change in service or policy. For example,
improved life expectancy of the population.
• Involving stakeholders
• Collecting data on the outcomes / consequences of the intervention in an
ongoing manner.
• Not double counting the consequences of the different outcomes within a process.
• If relevant, establishing how long the outcomes last. This contributes to the
modelling of the consequences of the intervention.

• Financial proxies: Monetizing a good or service without a price.

• Sometimes simple: finding a comparable item with a cost.
• Revealed preference methods – inferring the price of an item from the purchase
decision of an individual engaging in some market transaction.
• Contingent valuation (stated preference methods)- asking individuals how they
assign values to public goods that do not have a market price.
• Willingness to pay, willingness to accept.

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 Stage 4: Establishing Impact
• Deadweight:
• A measure of the outcome that would have been achieved in the absence of the
intervention by the social enterprise.
• Benchmarking the performance relative to some index of outcome in the
absence of one’s intervention.
• Example: reduction in reoffending rates amongst ex-offenders as a
consequence of the intervention and national average re-offending rates.
• Looking at the historic trend to assess whether the trend has changed following
the intervention.
• Or alternatively, at a control group, to assess the effect of an intervention on one
group relative to the effect on another group that has not received the
intervention.

• Displacement:
• To what extent does the outcome that we intend to achieve, displace other
outcomes that would have been achieved regardless of our intervention.
• Example, a London borough reduces crime by putting on more lighting, but the
crime is simply displaced to the neighbouring borough.
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 Stage 4: Establishing Impact, cont.
• Attribution:
• Assessment of how much of the outcome was caused by other organizations or
people.
• “To what extent is the outcome the consequence of our intervention, when there
are multiple interventions seeking the same outcome simultaneously?”
• For example, a cycling initiative is introduced concurrently with a congestion
charge and a public information programme regarding the environment.
• Overall, the scheme has been successful.
• The cycling scheme has contributed to the improved emissions because some motorists now
cycle.
• We need to attribute the overall decline in emissions to the different initiatives to ascertain how
much is attributable to the cycling scheme.

• Drop-off
• In future years the amount of outcome from an intervention is bound to decline
or be subject to influence by other factors.
• The social benefits arising from an intervention decline over time.
• A factor is used to reduce the impact of an intervention over successive years.
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 The Social Return on Investment Ratio
• Social Return on Investment is the ratio of the present value of the benefits
associated with a social project divided by the total investment.
• That is: total present value of the impact divided by total investment.

SROI = Present Value of Outputs from the Project /

Value of inputs

Net SROI = Net Present Value of Outputs from the Project /

Value of inputs

• Where the present value of the impacts from the project is, for example:

Time Year 1 Year 2 Year 3 Year T

Present Value = Impact/ + Impact/ + Impact/ + … Impact/
1 2 3 t
(1+r) (1+r) (1+r) (1+r)
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 Summary

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 Summary of Lecture 7
• In this lecture we considered two topics relating to performance
measurement.
• First, we introduced financial ratios.
– We discussed return on investment (ROI) ratios such as a) Return on Capital
Employed and b) Return on Equity.
– We decomposed ROCE into ratios of margin and efficiency.
– We decomposed ROCE into ratios of margin, efficiency and leverage.
– We noted the role of these measures in Alfred Chandler’s (1963) account of the
rise of the multi-divisional firm in the first half of the twentieth century.
– We considered ratios comprising the working capital cycle, or “cash conversion
cycle” (Apple case)
– In the seminar we will analyse Apple’s ratios.
• Second, we introduced Social Return on Investment
– A cost / benefit analysis of the ratio of present value of the financial value of
impact to the value of the investment used to create that impact.
– This is a cost / benefit analysis comparing value of benefit (impact) to investment
made.
• Third, we summarized the lecture.
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 Questions for the Financial Policy at Apple Case
• From the beginning of 2000 until its peak in 2012, Apple’s stock
price rose from $27.97 to $702.10, an increase of over 25 times.
What specific attributes of their operational performance account
for this stock performance?

• Apple’s stock decreased by 37% from its peak in 2012 until the
end of March 2013, from $702.10 to $442.66. Again, what specific
attributes of their operational performance account for this stock
performance?

• Why does Apple hold so much cash? How much “excess” cash
do they have? How much cash would they have after five years if
they distributed all of their excess cash to shareholders in 2012?
Use exhibit 10 in the case to forecast Apple’s financial status over
the next five years.

Global Masters in
Management
 Appendix 1:

R&F Enterprises
Financial Statements
(Please see Week 2)

Global Masters in
Management
 R&F Enterprises Income Statement

(£)
Revenue 171,000
Cost of Goods Sold - 135,000
Operating Profit 36,000
Interest Expense - 5,000
Net Profit 31,000

Global Masters in
Management
 R&F Enterprises Balance Sheet
Assets (£)
Plant, Property & Equipment 250,000
Inventories 20,000
Trade Debtors (Receivables) 66,000
Pre-paid Expenses 20,000
Cash 290,000
Total Assets 646,000

Liabilities
Trade Creditors (Payables) 75,000
Non-current Liabilities 50,000
Total Liabilities 125,000

Shareholders’ Equity
Share Capital 500,000
Retained Profit 21,000
Total Equity 521,000

Total Liabilities & Equity 646,000

Global Masters in
Management
 Rafael & Fernando Transaction Worksheet
Plant, Net Income - Net Income -
Net
Property & Trade Pre-paid Trade Non-Current Share Income - Cost of Interest Retained

(£) Equipment Inventories Receivables Expenses Cash Creditors Liabilities Capital Revenue Goods Sold Expense Earnings

Initial cash injection 500,000 500,000

Loan from Javier 50,000 50,000

Purchase of goods for cash - 80,000 - 80,000

Sale of goods for cash 105,000 105,000

Purchase of goods on credit 75,000 75,000

Sale of goods on credit (revenue) 66,000 66,000

Sale of goods on credit (cost of goods sold) -55,000 - 55,000

Interest - 5,000 - 5,000

Dividends - 10,000 - 10,000

Purchase of building 250,000 - 250,000

Insurance payment 20,000 - 20,000

Totals 250,000 20,000 66,000 20,000 290,000 75,000 50,000 500,000 171,000 - 135,000 - 5,000 - 10,000

Net earnings for the year 171,000 - 135,000 - 5,000 31,000

Retained earnings 21,000

Global Masters in
Management
 Appendix 2:
Equity Investment Styles

(Please see investment ratios)

Global Masters in
Management
 Equity Investment Styles
• Value oriented investment policy
– Absolute (Contrarian) Value
• Purchase stocks trading at a discount to an ‘intrinsic
value’

– Relative Value
• Purchase stocks that are cheap relative to other stocks in
their sector

• Growth oriented investment policy

– Growth at a Reasonable Price (GARP)
• Purchase reasonably priced stocks demonstrating
earnings momentum

– Aggressive Growth
• Purchase stocks demonstrating very strong future
prospects or current earning momentum
Global Masters in
Management
 Earnings Expectations Life Cycle
Growth investor sells
“Growth”

EPS Momentum Torpedoed

Growth Estimate Negative Earning

Surprise
investor buys Revision
Earning Revision
Value investorPositive
Surprise
sells. Models “Dogs”

Positive Neglect
Surprise
Contrarians

Value investor buys

Global Masters in
Management
 My Contact Details
Dr. Yally Avrahampour
Associate Professor (Education)
Department of Management
Room MAR 5.24
Email: [email protected]

Please be in contact to arrange a time to discuss any questions

you may have.

During term my office hours are Mondays 16.00 – 18.00,

Wednesdays 16.30-18.30) or at a time that we agree together.
Please email me to arrange a time.

I look forward to hearing from you and to discussing the course

with you.
Global Masters in
Management