Property and capital Property and capital structure of the firmstructure of the firm

Each business needs tangible and intangible resources: buildings, machines, material, means of transport, etc., which are together called „properties“ and each item „asset“.To get these properties, each company needs some sources - so called „capital“ (internal or external). Capital resources are called liabilities.

One of the main aim of business activities is to keep assets and financial stability, which we understand as an ability to make and to keep a balanced relationship between assets and used capital.

Balance sheetBalance sheet

- p- providerovidess information about the information about the enterprise´s financial conditions and enterprise´s financial conditions and operationsoperations,,

- is- is important for financial analysis and important for financial analysis and controlcontrol,,

- - is a financial picture of the enterprise at is a financial picture of the enterprise at the close of business on a particular the close of business on a particular date (end of a month, a quarter, a year)date (end of a month, a quarter, a year)..

Balance sheetBalance sheet

ASSETSASSETS LIABILITIESLIABILITIES

A. Long-term assetsA. Long-term assets A. Internal capitalA. Internal capital

A.a) Long-term intangible assetsA.a) Long-term intangible assets A.a) Basic capitalA.a) Basic capital

A.b) Long-term tangible assetsA.b) Long-term tangible assets A.b) Capital fundsA.b) Capital funds

A.c) Financial investmentA.c) Financial investment A.c) Funds from profitA.c) Funds from profit

A.d) Economic resultA.d) Economic result

B. Current AssetsB. Current Assets B. External capital (sources)B. External capital (sources)

B.a) InventoriesB.a) Inventories B.a) ReservesB.a) Reserves

B.b) Bank accounts B.b) Long-term debtsB.b) Long-term debts

B.c) Cash (money) B.c) Short-term debtsB.c) Short-term debts

B.d) Demands B.d) Bank loans B.d) Bank loans

B.e) Short-term stocks and bonds

∑ ∑ Total assets Total assets == ∑ ∑ Total liabilitiesTotal liabilities

I. A S S E T SI. A S S E T S

A) Long-term assetsA) Long-term assets

In the balance sheet it is called „fixed assets“.

It is the equity, which is used in the firm longer than 1 year.

There are 3 basic groups: a) intangible, b) tangible, c) financial assets.

A.a) Long-term intangible assetsA.a) Long-term intangible assets

- the price of individual asset is higher

than 60 000 CZK and the period for using is

longer than one year.

Examples: things like copyrights, patents, intellectual

property, and goodwill, software, technical

and other business knowledge …

A.b) Long-term tangible assetsA.b) Long-term tangible assets

a) land, buildings, art work, collections

b) personal chattels - equipment (machines, means of transport … i. e. moveable assets, when their price is higher than 40 000 CZK and the period of usability is longer than 1 year.)

Long term tangible assets are not used at once, but there is some depreciation every year (exceptions are land, art work and collections) and according to this principle is the value of the asset transferred to the costs of the firm.

A.c) Financial investmentA.c) Financial investment

a) Financial participations and shares in other firms, which the company holds longer than 1 year.

b) Investment stock and bonds as shares, debt securities, treasury notes, termed deposits with the maturity longer than 1 year.

c) Given loans with the maturity longer than 1 year.

Valuation of long-term propertiesValuation of long-term properties

a) Purchase price = price of acquisition + costs

connected with the acquisition,

b) Prime costs – for the assets, made in own activity

c) Price of procurement – the price for the financial

assets

d) Replacement price – price for gifts, presents –

valuation of these things by expert

Entrance price is:

Depreciation in Depreciation in CzechCzech accountingaccounting

The The allocationallocation of the cost of an of the cost of an assetasset over over a period of time for a period of time for accountingaccounting and and taxtax purposespurposes..

Assets over a purchase price of CZK Assets over a purchase price of CZK

4040 000 cannot be directly expensed and 000 cannot be directly expensed and must be depreciated. The annual must be depreciated. The annual depreciation rate allowed by law is tax depreciation rate allowed by law is tax deductible. deductible.

The Czech Income Taxes Act includes a definition of tangible fixed assets and the Czech Accounting Act defines intangible fixed assets.

Tangibles are those assets whose input price is over CZK 40 000 and whose expected operational and technical life exceeds 1 year (buildings, moveable assets).

Tangible fixed assets are divided into „6“ categories for depreciation purposes.

Intangible assets comprise industrial know-how and copyrights, software, technical and other business knowledge, etc.

Depreciation categoriesDepreciation categories

Depreciation categoryMinimum depreciation

period (in years)

1 buses, computers and office equipment, measuring and control devices, etc.

3

1a motor vehicles (except motocycles), road motor vehicles of category N1

4

2 machinery and equipment, lorries, tractors, objects of indrustrial property, ownership rights and technical know-how

5

3 metal structures, motors, metal products, machinery and equipment for the metal industry, ships, lifts, electric engines, etc.

10

4 gas and oil pipe-lines, water mains, pillars, chimneys

20

5 buildings, bridges, roads, tunnels, water works, cableways

30

6 buildings of hotels, museums, stores, libraries, schools

50

DepreciationDepreciation of long-term of long-term tangible properties (assets)tangible properties (assets)

1) Accounting depreciation – about this depreciation can decide the firm itself,considering the depreciation of the asset during the common using according to time or performance.

2) Tax depreciation – maximum amount of depreciation, given by the Law of Income Tax. There are 2 possibilities – equal depreciation – straight line method for each year or faster depreciation – accelerated tax depreciation.

Methods of depreciationMethods of depreciation

For tangible assets a company can use:For tangible assets a company can use:

straight-line depreciation straight-line depreciation

accelerated tax depreciation accelerated tax depreciation

a) Straight line depreciationa) Straight line depreciation

ANNUAL DEPRECIATION RATE (%)

ANNUAL DEPRECIATION = PURCHASE PRICE *

100

Depreciation rate/yearDepreciation rate/year

Depreciation Categories

Straight-line depreciation

Annual Depreciation Rates (%)

first year subsequent years

for increased purchase price

1

1a

20

14.2

40

28.6

33.3

25.0

2 11 22.25 20

3 5.5 10.5 10

4 2.15 5.15 5

5 1.4 3.4 3.4

6 1.02 2.02 2

b) Accelerated depreciationb) Accelerated depreciation

The accelerated depreciation method applies a series of “coefficients” to the purchase price

of the asset.

The depreciation is calculated as follows:

in the first year the depreciation is the purchase price divided by the coefficient,

in subsequent years the depreciation is twice the residual value, divided by the appropriate coefficient less the number of years for which depreciation has been claimed.

Accelerated DepreciationDepreciation

Accelerated depreciation methods are popular for writing-off equipment that might be replaced before the end of its useful life since the equipment might be obsolete (e.g. computers).

An accelerated depreciation is a method, which allows faster write-offs than the straight line method.

Coeficients for accelerated Coeficients for accelerated depreciationdepreciation

Depreciation Categories

Accelerated depreciation

Coefficients for accelerated depreciation K

first year(K1)

subsequent years (K2)

for increased purchase price

(K3)

1

1a

3

4

4

5

3

4

2 5 6 5

3 10 10 10

4 20 21 20

5 30 31 30

6 50 51 50

Accelerated depreciationAccelerated depreciation

Note: Annual depreciation = 2 * (purchase price – depreciations) / K2 – (N-1)

PURCHASE PRICE

ANNUAL DEPRECIATION (1ST YEAR) =

K1

2 * RESIDUAL VALUE

ANNUAL DEPRECIATION = K2 – (N – 1)

Rules for depreciationRules for depreciation- Amounts of computed depreciation shall be rounded up to the next whole Czech crown.

- Once the subject has elected to use a method for a particular asset this method may not be changed during the useful life of such asset.

- Sum of depreciations (acummulated depreciation) =

on the left side of the balance sheet with negative mark

- We make depreciations until 100 % of the purchase price.

There are not depreciated: land, art work and

collection.

Technical appreciation

Examples: expenses to building corrections and extensions, reconstruction and modernization of the property, additional equipment of cars … and its price is higher than 40 000 CZK per annum.

Reconstruction – the consequence of them is a change of the purpose or a change of the technical parameters.

Modernization – is an enlargement of facilities or usebility of the property.

Technical appreciation increases the entrance price, let us say residual value of the property and it must be depreciated.

B) Current AssetsB) Current Assets

It is an asset, which form changes in other form:

MONEY → MATERIAL → UNFINISHED PRODUCTION → FINISHED PRODUCTION → BANK ACCOUNTS → MONEY

In the firm, there are two basic forms of assets:

a) Material form (inventories),

b) Form of money (bank accounts, cash (money), short-

term stocks and bonds, demands).

B.a) InventoriesB.a) Inventories

1) Purchased InventoryInventory I. Purchased material

a) raw material (basic material),b) spare parts,c) wrappings.

II. Stocked material (goods)

2) InventoryInventory of self-productiona) unfinished production,b) half-finished products of self-production,c) finished production,d) animals.

Valuation of inventoriesValuation of inventories

Stock (inventory) is valued at cost for raw materials and goods purchased for resale. Cost includes expenses incurred to bring the goods to their present state and location, i.e. costs include freight and customs duties where applicable.

Czech legislation specifically provides these methods:1) weighted arithmetical average of purchase prices 2) FIFO methods to valuate stock but3) LIFO4) replacement-cost method cannot be used.

Valuation of inventoriesValuation of inventories

1) Method FIFO – ( first in, first out) – material, which came to the stock as first, leaves as first and is valueted by the price of the oldest material.

2) Method LIFO – a method of valuing your inventory that assumes any inventory you sold was from the last inventory you purchased (= last in, first out). It is prohibited in the Czech Republic.

3) Weighted arithmetical average of purchase prices – under the weighted average approach, both inventory and the cost of goods sold are based upon the average cost of all units bought during the period.

Example of 1 - Principle of FIFO method:

DateDate Movement in Movement in the stockthe stock

KilogramsKilograms Price Price CZK/KilogramCZK/Kilogram

2. 3.2. 3. material entrymaterial entry 100100 1515

8. 3.8. 3. material entrymaterial entry 300300 1212

14.3.14.3. material entrymaterial entry 200200 1616

17.3.17.3. issueissue 130130 ??

Valuation of issue on 17. 3.: (100 x 15) + (30 x 12) = 1 860 Kč

DateDate Movement Movement in the in the stockstock

Kilo Kilo gramsgrams

Price Price CZK/Kilo CZK/Kilo

gramgram

Value of the Value of the storestore

Average priceAverage price

CZK/KilogramCZK/Kilogram

2. 3.2. 3. material material entryentry

100100 1515 1 5001 500 15,0015,00

8. 3.8. 3. material material entryentry

300300 1212 ( 300 * 12 ( 300 * 12

+ + 1 5001 500) =) =

5 1005 100

((5 1005 100/ / 100100++300300) =) =

12,7512,75

14.3.14.3. material material entryentry

200200 1616 8 3008 300 13,8313,83

17.3.17.3. issueissue 130130 13,8313,83 (8 300 – 1 798) =(8 300 – 1 798) = 6 5026 502

13,8313,83

Valuation of issue on 17. 3.: 130 x 13,83 ≈ 1 798 Kč

Example of 3 - Principle of Weighted arithmetical average of purchase prices:

B. b - e) Forms of money current assetsB. b - e) Forms of money current assets

b) Bank accounts

c) Cash (money in cash desk)

d) Demands (outstanding debts of our customers)

e) Short-term stocks and bonds

II. L I A B I L I T I E SII. L I A B I L I T I E S

Capital structureCapital structure It is a structure of sources of which the enterprise´s property originated. According to the origin of the source we distinguish internal and external capital. The total amount of business capital depends on:

size of the enterprise, level of mechanization, automatization and robotization, speed of capital´s turn-over, organization of the sales department.

The firm should have just as much capital as it needs. If it has more capital, it is overcapitalized (it does not bring the sufficient rate of return), and vice versa – if it has less capital, it is undercapitalized (some faults may occur in the enterprise run).

A) Internal capitalA) Internal capital

It belongs to the firm´s owners. Its share on the total business capital is an indicator of financial certainty (independence) of the enterprise. It consists of these parts:

a) basic capital,

b) capital funds,

c) funds from profit,

d) economic result.

A.a) Basic capitalA.a) Basic capital

Ltd., joint-stock company and cooperative must duly create it:

- in Ltd. and in cooperative it includes deposits of

partners;

- in joint-stock company it is a summary of nominal values

of issued stocks.

Ltd.: min. 200 000 CZKmin. 200 000 CZK, e, each partner min. 20 000 CZKach partner min. 20 000 CZK Joint-stock company: min. 2 000 000 CZK without tender min. 2 000 000 CZK without tender of stocksof stocks, , min. 20 000 000 CZK with tender of stocksmin. 20 000 000 CZK with tender of stocksCooperative: min. 50 000 CZKmin. 50 000 CZK

A.b) Capital fundsA.b) Capital funds

These funds represents „external capital“ (for example – from gifts, grants on acquisition of firm´s property …), which does not have a character of external capital!

The most significant item is a share premium (= emissive agio) – it is a positive difference between an emissive course of shares and a nominal value of shares.

A.c) Funds from profitA.c) Funds from profitThey are created:

- directly from the law (lawful reserve fund, indivisible

fund), or

- on the base of self decision (e. g. social fund, fund of

awards, etc.)

Reserve fund is duly created in Ltd. and in joint-stock company, it is created from the net profit (= profit after taxation) and it is possible to use it only to cover the company´s loss. An indivisible fund performs then the analogical function in the cooperative.

A.d) Economic resultA.d) Economic result

a) Economic result of current accounting period - a profit or a loss.

b) Retained profit of last years - it represents the part of profit which was not divided into the funds or that was not paid out in the form of dividends and it is taken over to another period.

c) Outstanding loss of last years - a loss, that was not covered from the reserve fund.

B) External (capital) sourcesB) External (capital) sources

External capital represents the debts, that must be liquidated in a certain period. According to the term of expiration we distinguish short-term and long-term external sources.

Structure of external sources:

a) reserves,

b) long-term debts,

c) short-term debts,

d) bank loans.

B.a) ReservesB.a) Reserves

- they serve to cover possible risks (e. g. exchange rate loss) and future expenses (e. g. reparations of tangible assets).

B.b) Long – term debtsB.b) Long – term debts

= debts with the term of expiration

longer than 1 year

- they serve to the financing of long-term assets (issued business bonds, bills of exchange and long-term received advances).

B.c) Short – term debtsB.c) Short – term debts

= debts with the term of expiration

shorter than 1 year

- they serve to the financing of a current company´s run.

- we talk about:

- supplier credits,

- advances received from customers,

- accounts payable towards employees, instituions of social security and state (outstanding taxes) …

B.d) Bank loansB.d) Bank loans

- long-term (term of expiration > 1 year),

e. g. investment credit

- short-term (term of expiration < 1 year),

e. g. operation credit

Optimal capital structureOptimal capital structure

= > rate of indebtedness

Optimal capital structure of a company = searching of minimum of WACC – Weighted Average Costs on Capital

Average costs on capitalAverage costs on capital

V

Sk

V

B*T)kWACC ei *1(*

WACC – weighted average costs on total capital (%)ki – costs on external capital before taxation of a profit (%)T – rate of profit´s taxation (decimal number)ke – costs on internal capital after taxation of a profit (%)B – market value of external capital in CZKV = B + S – total business capital in CZKS – market value of internal capital in CZK

Theory of U - curveTheory of U - curve

3028262422201816141210

86420

0 10 20 30 40 50 60 70 80

Weighted Average Costs on Capital = WACC

indebtedness (%)

cost

s on

cap

ital

(%)

OPTIMUM

costs on internal capital ke

costs on external capital ki