Describe how value-added is calculated. To what extent are value added, cash flow, and profit connected to a company’s sales performance? Throughout this essay I will be exploring how value added is calculated and to what extent value added, cash flow and profit are connected to a company’s sales performance. I will do this by introducing value added and the formulas in which they are calculated, mathematically and through accounting, the purpose why value added is calculated and the theory of Cox.
Moreover, I will explain how value added is related to a company’s sales performance using an extended example.
Nonetheless, cash flow is a measurement of a company’s money generated in the company in order to pay for expenses, and how this rapports to sales performance. I will then further explain how profit is related to sales. Cox Bernard concluded that value added was the profound ‘way to get at meaningful figures of output would be to take the value of production in the economy minus the cost of bought-in materials and services’ (Cox, 1979), it is used ‘to measure the income’ (Cox, 1979).
The excess remainder is distributed to labour costs, social costs, depreciation and operating profits which all add up to true value added.
Value added is calculated to sustain employment, and to measure a company’s growth; the money left is fundamental in order to pay the suppliers and the workforce that sustains employment. To measure productivity, which is derived from sales performance value added per employee is used, it shows that the higher the rates the higher the productivity, which highlights output and efficiency.
By implementing the value added to sales ratio, this allows one to view physical productivity whether it is genuinely achieved or through the reduction of employees and reducing expenses; value added divided by sales.
Moreover, financial factors strongly link to sales performance because they are the outcomes of the ‘physical production’ (Sukhdev, 2011). By using value added we explore and understand the characteristics of the firm better, labour share and cash flow of value added are considered. Labour share is crucial as it indicates if there is a high labour share, if there is, the firm is prone to negative market conditions and economical changes.
However, cash flow as a percentage of value added highlights how ‘cash-generative’ (Sukhdev, 2011) an organisation is, and how sufficient the inflow is for ‘the claims of investment and profit distribution’ (Sukhdev, 2011). ‘Cash flows are inflows and outflows of cash and cash equivalents’ (Van Greuning,2005) which are fundamental factors in regards to the company’s sales performance. This is because cash flow is money generated through sales into the company in order to pay for overheads and liabilities, which is why it’s not profit. This source of money is only money that flows in and out of the company.
There are three aspects of cash flow, cash flow from operations, from investing and cash flow from financing which account to the company’s sales performance. Cash from operations or ‘Operating activities are principal revenue-producing activities and other activities that do not include investing or financing activities’ (Van Greuning, 2005), it is the firm’s formidable source of cash generated in contrast to external funds from investing activities. The equation for operating cash flow is operating cash flow = Earnings Before Interest And Taxes + Depreciation – Taxes.
Operating profit underlines the measurement of cash an organisation is producing because it includes non-cash adjustments such as depreciation and amortization to net income and it involves the alteration in working capital which nonetheless also supply’s cash. These aspects are fundamental in concluding the amount a business is generating, therefore we recognise that ‘operating cash flow correlates with net income’ (Van Greuning, 2005) greatly as it permits one to distinguish profitability from net working capital.
However, EBITDA abolishes a few irrelevant aspects and allows one to highlight a fine indication of core profit trends. This affects the decrease of net income and requires increased revenue of sales in order to restore profit. Furthermore, if an organisation does not have enough cash resources in order to settle its current liabilities, this will highlight great inefficiency with stock turnover not being sold. A good company such as Sainsbury’s we see is healthy because revenue is recognised from inventories sold – this revenue allows cash to flow in order to pay for short term and long-term liabilities.
It is evident that there are insufficient cash flowing into the company from investing activities and financing activities, which are shown by the brackets. As we can see from Appendix 1, operating cash flow before changes as it decreases by -? 78m from +? 92m in 2010. This shows that Sainsbury’s is not as healthy because the operating cash flow has reached minus, meaning that this cash will not meet short term or long-term liabilities, or even any retained cash from the inflow for profits.
Therefore, from this example, cash flow has a strong rapport with a company’s sales performance because after adjustments have been made and expenditures met with the inflow cash, they do not have enough capital for retained profit or for capital expenditures such as purchasing technological materials which will allow them to stay competitive and to grow. Cash flow is connected to sales performance because after paying the expenditures, cash accounts for profit generated. Moreover, another aspect of cash flow, which rapports to the sales performance, is the cash flow from investing.
Cash flow from investing activities is positives or losses from investments in the operating market. This cash flow accounts for the inflow of cash as it is sourced from the sales of investments. The usage of this cash is accounted for profit if there are any returns. Appendix 1 (J. Sainsbury’s, 2005) Profit is what constructs the company’s sales performance because it’s function determines the growth of the company, and their sales performance, such as the net profit and gross profit margin.
The profit equation is total revenue – total costs, ‘In accounting terms [… ] the difference between total revenues [or cost recovered from the market] minus total costs of materials, labour and capital costs’ (Haslam, 2000). This shows how much revenue was obtained minus the overheads in order to recover costs to highlight the profit and sales performance. Distinctly profit is strongly connected to a company’s sales performance, because if the average selling rice per product cost recover’s, it permits gross profit for Sainsbury’s, and any excess after paying for overheads and taxes is considered as profit, this is why sales and profit both have a rapport. By looking at Sainsbury’s operating profit figures we see that ‘operating profit increased by 10. 0 per cent to ? 738 million (2009/10: ? 671 million) (J. Sainsbury’s, 2011). This reflected the solid sales performance and the delivery of cost efficiency savings’. (J. Sainsbury’s, 2011)
In order to gain profit one must state the obvious and make a sale to earn profit, in the majority of the firms as sales performance increase profits increase too, and vice visor if profits decrease. Therefore that profit is connected to company sales performance, another external example is retail business Ann Taylor who’s ‘Revenue rose 12 percent to $564 million from $505. 3 million, as Ann Taylor brand sales rose 3 percent to $229. 7 million and sales at the more casual Loft chain jumped 19 percent to $334. 3 million’ (Bloomberg, 2011).
As we can understand from this appendix that Sainsbury’s sales increase sales by 5. 7% over the year and the profit figures change from ? 585m to ? 640m with nearly a 10% increase. The relation of sales performance and profit is underlined as from 2009/10 – 2010/11 sales increased whereby profit increased too. However, sales performance is not just solely determined by revenue, because weak performances affect sales in regards to the net income per employee, for this value added per employee is used to measure the productivity.
The higher the rates, the higher the productivity, leading to a connection of profit from sales performance. To conclude, value added is a concept which measures the income, in other words value added is ‘sales revenue minus purchase costs, or the additive view that is the sum of profits, depreciation, interest costs, dividends and taxation (Haslam, 2000). Value added is highly significant as it measures many areas, such as productivity using labour share, which forecasts how sensitive a business is to changes, also, value added to sales ratio trongly links to sales performance as we see how it was actually achieved. Cash flow of value added underlies how ‘cash generative’ (Sukhdev, 2011) in order to pay for expenses. We can gather poor/high growth, productivity and output. By looking at a company’s cash flow forecast, we can underline trends through which was the best cash generator, whether it was from operations, investing activities or financial activities. By looking at Sainsbury’s cash flow we formulated the conclusion that operating activities was best because it showed true profitability.
Cash flow connects to sales performance as it is the root to a company’s growth and ‘is a powerful indicator of corporate vitality & financial health because it is an index of a organisations financial ability to sustain corporate competitiveness’ (Haslam, 2005). Profit is the key factor to a company’s sales performance, because increased profits show the increased number of sales performance, this is because from sales we meet cost recovery, from cost recovery gross profit as average selling price is exceeded and net profit is achieved.
Overall, every aspect of financial information correlates to sales performance, because without increased sales we won’t receive an inflow of cash, which paves us to profit, and value added which allows us to critically measure income and productivity. Describe how value-added is calculated. To what extent are value added, cash flow, and profit connected to a company’s sales performance? References: 1. Bernard Cox (1979). Value added: An appreciation for the accountant concerned with industry.
England: Heinemann. 12-14. 2. Colin Haslam, Alan Neale, Sukhdev Johal (2000). Economics in a Business Context. 3rd ed. Surrey: Thomson Learning. 5. 3. Colin Haslam, Alan Neale, Sukhdev Johal (2000). Economics in a Business Context. 3rd ed. Surrey: Thomson Learning. 38. 4. Colin Haslam, Alan Neale, Sukhdev Johal (2000). Economics in a Business Context. 3rd ed. Surrey: Thomson Learning. 34 5. Hennie van Greuning, World Bank (2005). International financial reporting standards: a practical guide.
Washington: World Bank. 34 6. J Sainsbury’s. (2011). Sainsbury’s annual report. Available: http://www. j-sainsbury. co. uk/media/171813/ar2011_report. pdf. Last accessed 6th Dec 2011. 7. Sukhdev Johal, 2011, MN1015 Business Analysis and Decision Making, Lecture 7. 8. The Associated Press. (2011). Ann Inc. 3Q profit rises on Loft sales growth. Available: http://www. businessweek. com/ap/financialnews/D9R36SQ82. htm. Last accessed 6th Dec 2011.
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