Jocosol_Unit 6 Financial Ca[ial Olay finao

zmsb

1. FINANCIAL CAPITAL OUTLAY MA. JOY JOCOSOL Eastern Visayas State University EPM 612 Economics of Education Ph.D.- EPM Student

2. Capital Budgeting Capital Expenditure Financial Analysis TOPIC OUTLINE

3. The process of identifying, analyzing, and selecting investment projects whose returns (cash flows) are expected to extend beyond one year (Peterson and Fabozzi , 2002). Before an organization thinks about capital budgeting, it must first determine its corporate strategy - its broad set of objectives for future investment. Capital Budgeting

4. To influence the firm’s growth in the long run. To affect the risk of the firm. To involve a huge amount of funds. It can not easily be changed without considerable financial loss. Significance of Capital Budgeting

5. Stage 1. Investment Screening and Selection Projects consistent with the corporate strategy are identified by the production, marketing, and research and development management of the company. Once identified, projects are evaluated and screened by estimating how they affect the future cash flows of the company and, hence, the value of the company. Capital Budgeting Process

6. Stage 2. Capital Budget Proposal A capital budget is proposed for the projects surviving the screening and selection process. The budget lists the recommended projects and the amount of investment needed for each. Capital Budgeting Process

7. Stage 3. Budgeting Approval and Authorization Projects included in the capital budget are authorized, allowing further fact gathering and analysis, and approved, allowing expenditures for the projects. Capital Budgeting Process

8. Stage 4. Project Tracking Project tracking is the communication link between the decision-makers and the operating management of the company. For example, tracking can identify cost over-runs and uncover the need for more marketing research. Capital Budgeting Process

9. Stage 5. Post-completion Audit This involves a comparison of the actual cash from the operations of the project with the estimated cash flow used to justify the project. Capital Budgeting Process

10. New Products or expansion of existing products Replacement of existing equipment or buildings Research and development Exploration Other (e.g., safety or pollution related) Classification of Investment Project Proposals

11. 1. ACCOUNTING RATE OF RETURN The accounting rate of return is based on the accounting profit. Thus they maybe a need to adjust the cash flow in order to obtain profit figure to be used in the calculation. Estimated average profits x 100% Estimated average investment Capital Budgeting Techniques

12. 1. ACCOUNTING RATE OF RETURN Advantages  Easy to understand; Widely used; and Data readily available to calculate it.   Disadvantages It does not take into account the time value of money; and It is based on accounting profits and these are subjective. Capital Budgeting Techniques

13. 2. PAYBACK METHOD It refers to the number of years required to recover the initial investment in the form of cumulative cash inflows. Cost of the investment Annual net cash flow Capital Budgeting Techniques

14. 2. PAYBACK METHOD Significance it provides an initial screening process and is based on the estimated relevant cash flows. it considers the time value of money and the risk associated with the expected cash flows Capital Budgeting Techniques

15. 2. PAYBACK METHOD Limitations ▪ The simple payback takes no account of the timing of cash flows ▪ There is no clear objective decision rule as to what length of time should be set as a minimum payback. Despite these serious disadvantages, the payback method is useful in that it provides an initial screening process and is based on the estimated relevant cash flows. The discounted payback period method is an attempt to overcome some of the problems associated with the payback period. Specifically, it considers the time value of money and the risk associated with the expected cash flows. The discounted payback period of investment is defined as the length of time required for the generation of sufficient discounted cash flows to recover the initial cost of the investment. The appropriate rate for which future cash flows are discounted is usually the weighted average cost of capital of the company, since it is the rate that reflects the risk associated with the company. The discounted payback decision rule is that an investment should be accepted if its discount payback period is less than some pre-specified number of years. If a choice between projects must be made, the one with the shortest payback must be undertaken. Although the discounted payback period method is an improvement on ordinary payback, the problem with the arbitrary choice of cut¬ off remains, while the attractive features of the payback method - simplicity and ease of use -are lost. Capital Budgeting Techniques

16. 3. NET PRESENT VALUE It is one of the capital budgeting techniques, recognizing the time value of money. Decision Criterion: If NPV is greater than zero accept the project and vice versa. ∑ {Net Period Cash Flow / (1+R) T } - Initial Investment where R is the rate of return , and T is the number of time periods. Capital Budgeting Techniques

17. 3. NET PRESENT VALUE Advantages ▪ Shareholder wealth is maximised ; ▪ It takes into account the time value of money; and ▪ It is based on cash flows, which are less subjective than profits. Disadvantages ▪ It can be difficult to identify an appropriate discount rate; ▪ Some managers are unfamiliar with the concept of NPV; ▪ Cash flows are usually assumed to occur at the end of a year, but in practice this is over simplistic. Capital Budgeting Techniques

18. 4. PROFITABILITY INDEX TECHNIQUE Profitability index (PI) also known as Benefit Costs Ratio measures the present value of returns (cash inflows). It is a relative measure which is obtained by dividing the present value of future cash inflows by the present of cash out flows. PI = PV of cash inflows/PV of cash out flows Capital Budgeting Techniques

19. 5. INTERNAL RATE OF RETURN It is based on the principle of discounting future cash flows and will normally give the same accept/reject decisions and will rank investment projects in the same way as the NPV method. Capital Budgeting Techniques

20. 5. INTERNAL RATE OF RETURN Advantages ▪ It takes into account the time value of money, which is a good basis for decision-making; ▪ Results are expressed as a simple percentage, and are more easily understood than some other methods; and ▪ It indicates how sensitive decisions are to a change in interest rates. Disadvantages ▪ Projects with unconventional cash flows can have either negative or multiple IRRs - this can be confusing to the user; ▪ IRR can be confused with ARR or Return on Capital Employed since all methods give answers in percentage terms - hence, a cash-based method can be confused with a profit-based method; ▪ It may give conflicting recommendations to NPV; ▪ Some managers are unfamiliar with the IRR method; ▪ IRR cannot accommodate changes in interest rates over the life of a project; and ▪ It assumes funds are re-invested at a rate equivalent to the IRR itself, which may be unrealistically high. Capital Budgeting Techniques

21. 5. INTERNAL RATE OF RETURN Disadvantages ▪ Projects with unconventional cash flows can have either negative or multiple IRRs - this can be confusing to the user; ▪ IRR can be confused with ARR or Return on Capital Employed since all methods give answers in percentage terms - hence, a cash-based method can be confused with a profit-based method; ▪ It may give conflicting recommendations to NPV Capital Budgeting Techniques

22. Capital expenditure ( CapEx ) is money that is spent to acquire, repair, update, or improve a fixed company asset, such as a building, business, or equipment. A CapEx is different from an everyday business, which falls under the operating expense category. Capital Expenditure

23. Capital expenditure ( CapEx ) is money that is spent to acquire, repair, update, or improve a fixed company asset, such as a building, business, or equipment. A CapEx is different from an everyday business, which falls under the operating expense category. CapEx = PPE (current period) – PPE (prior period) + Depreciation (current period) Expenditures of the national government for infrastructure and other capital outlays grew to P1.02 trillion from January to November 2023 from only P861.8 billion in the same period in 2022, according to the Department of Budget and Management. Capital Expenditure

24. Acquiring, or buying, a fixed tangible asset, such as a building, or intangible asset, such as a patent or license. Upgrading an existing asset to expand its capacity or capability, such as a computer network or major equipment. Renovating an obsolete or non-functioning asset to make it usable. Repairing an asset to make it usable once again. Adapting an asset for a new use, different from what it had been previously used for. Starting or acquiring a new business. Capital Expenditure Examples

25. Personal services, like salaries and wages, social security contributions, overtime pay, etc.; Maintenance and other operating expenditures, such as traveling expenses, supplies and materials, water, illumination and power Services, rent, etc.; Interest payments; Allotments to Local Government Units; Subsidies to government-owned and controlled corporations. 2. What is the government's policy regarding current operating expenditures The government's policy regarding current operating expenditures maybe summarized as follows: • Limit the growth of current operating expenditures with provisions for inflation adjustments; • Encourage cost reduction measures in operation, particularly overhead expense items; • Provide adequate maintenance funds for infrastructure facilities; and. • Control the growth of spending for personal services within the level that can be sustained by available resources. 3. What are the capital outlays of the national government? The capital outlays of the national government are appropriations spent for the purchase of goods and services, the benefits of which extend beyond the fiscal year and which add to the assets of government, including investments in the capital stock of government-owned or controlled corporations and their subsidiaries. The capital outlays of the national government may be broadly classified as follows: infrastructure outlays, equity contributions to government corporations, capital transfers to local government units, and other capital outlays. Capital expenditures, particularly those classified as capital goods or durable goods to be used for non-military and productive purposes, such as construction of roads and bridges, dams, power and irrigation works, schools and hospitals, are generally desirable because of their high multiplier effect on the economy, i.e., they stimulate the growth and expansion of economic activities of the private sector and facilitate the integration of industries. 4. What are infrastructure expenditures? Infrastructure expenditures refer to the disbursement of funds for the construction of various basic public works of the country, such as roads, ports, airports, water supply, irrigation, and other capital investments, the benefits of which extend to the general public. In the national budget, infrastructure expenditures generally refer to the capital outlays of the Department of Public Works and Highways and the Department of Transportation and Communication, the School Building Program of the Department of Education, Culture and Sports, and the national irrigation projects of the Department of Agriculture. 5. What constitute the other capital outlays of the government? The other capital outlays of the government consist of land acquisition and land improvement outlays, buildings and structures outlays, acquisition of vehicles, aircraft, water transport vehicles, equipment, furniture, fixtures, etc. 6. What are capital transfers to local government units (LGUs)? Capital transfers to local government units (LGUs) pertain to the portion of the Internal Revenue Allotment (IRA) which accrue to LGUs equivalent to not less than twenty percent (20%) of their IRA allocations, earmarked for development projects such as the construction/improvement, repair and maintenance of local roads, concrete barangay roads/multi-purpose pavements, and the rehabilitation and improvement of communal irrigation projects/systems. 7. What are the equity contributions to government corporations? Equity contributions to government corporations refer to the national government investments in the authorized capital stock of government-owned or controlled corporations. 8. What are interest payments? Interest payments represent the cost of borrowed funds which form part and parcel of the cost of the items financed by the loan. Interest payments are, therefore, considered as the real expense item in the budget. 9. How is the national government budget sectorally allocated? The national government budget is allocated according to the following major sectors: social services, economic services, defense, general public services, and debt burden. Allocation for social services include those for: a) education, culture and manpower development; b) health services; c) social security, welfare, and employment; d) housing and community development; and, e) land distribution. Provision for economic services include those for: a) communications, roads and transportation facilities; b) agriculture, agrarian reform and natural resources; c) water resources development and flood control; d) trade and industry; e) power and energy; and f) tourism. Expenditures for defense include those that support the general effort to ensure national security, stability and peace which are indispensable to economic growth and development. General public services expenditures are those that are spent for: a) general administration such as general government stipulation fiscal affairs, foreign affairs and international commitments, electoral, audit, civil service and lawmaking functions; and b) public order and safety including various functions pertaining to law enforcement, maintenance of public order and safety and political administration. Expenditures for debt burden are those that go into the servicing of government's regular and assumed debts from domestic and foreign sources, including interest payments. 10. How are government expenditures categorized by cost structure? What is the significance of this categorization? The national government budget is broken down into the following cost categories: 1) general administration and support; 2) support to operations, and 3) projects. Expenditures for general administration represent those that are normally considered as agency overhead (i.e. the cost of general supervision) which the agency will incur to exist as a unit. Examples of expenditures for general administration and support are those spent for general management and supervision, human resources development, and for productivity incentive benefits. Support to operations refers to those activities that facilitate the performance of the agency's mandated functions and services. Examples of expenditures under this category are those that are meant for policy formulation and planning services; for program/project coordination, monitoring and evaluation; and for information management support system. Expenditures for operations are those that go to regular activities directly addressing the agency's mandates. They include expenditures for programs involving the production of goods; delivery of public services; regulation of societal activities; conduct of basic governance; or provision of general management and supervision of the entire government bureaucracy. Project expenditures are those that fund activities which result in the accomplishment of identifiable outputs within a designated period. Project expenditures may be sourced from foreign assistance or from local funding. The categorization of the budget by functional cost components allows for a better analysis of government expenditures to focus on more priority needs thus improving the quality of government spending. Major Current Operating Expenditures of the National Government

26. The capital outlays of the national government are appropriations spent for the purchase of goods and services, the benefits of which extend beyond the fiscal year and which add to the assets of the government, including investments in the capital stock of government-owned or controlled corporations and their subsidiaries. The capital outlays of the national government may be broadly classified as follows: infrastructure outlays, equity contributions to government corporations, capital transfers to local government units, and other capital outlays. Capital expenditures, particularly those classified as capital goods or durable goods to be used for non-military and productive purposes, such as construction of roads and bridges, dams, power and irrigation works, schools and hospitals, are generally desirable because of their high multiplier effect on the economy, i.e., they stimulate the growth and expansion of economic activities of the private sector and facilitate the integration of industries. 4. What are infrastructure expenditures? Infrastructure expenditures refer to the disbursement of funds for the construction of various basic public works of the country, such as roads, ports, airports, water supply, irrigation, and other capital investments, the benefits of which extend to the general public. In the national budget, infrastructure expenditures generally refer to the capital outlays of the Department of Public Works and Highways and the Department of Transportation and Communication, the School Building Program of the Department of Education, Culture and Sports, and the national irrigation projects of the Department of Agriculture. 5. What constitute the other capital outlays of the government? The other capital outlays of the government consist of land acquisition and land improvement outlays, buildings and structures outlays, acquisition of vehicles, aircraft, water transport vehicles, equipment, furniture, fixtures, etc. 6. What are capital transfers to local government units (LGUs)? Capital transfers to local government units (LGUs) pertain to the portion of the Internal Revenue Allotment (IRA) which accrue to LGUs equivalent to not less than twenty percent (20%) of their IRA allocations, earmarked for development projects such as the construction/improvement, repair and maintenance of local roads, concrete barangay roads/multi-purpose pavements, and the rehabilitation and improvement of communal irrigation projects/systems. 7. What are the equity contributions to government corporations? Equity contributions to government corporations refer to the national government investments in the authorized capital stock of government-owned or controlled corporations. 8. What are interest payments? Interest payments represent the cost of borrowed funds which form part and parcel of the cost of the items financed by the loan. Interest payments are, therefore, considered as the real expense item in the budget. 9. How is the national government budget sectorally allocated? The national government budget is allocated according to the following major sectors: social services, economic services, defense, general public services, and debt burden. Allocation for social services include those for: a) education, culture and manpower development; b) health services; c) social security, welfare, and employment; d) housing and community development; and, e) land distribution. Provision for economic services include those for: a) communications, roads and transportation facilities; b) agriculture, agrarian reform and natural resources; c) water resources development and flood control; d) trade and industry; e) power and energy; and f) tourism. Expenditures for defense include those that support the general effort to ensure national security, stability and peace which are indispensable to economic growth and development. General public services expenditures are those that are spent for: a) general administration such as general government stipulation fiscal affairs, foreign affairs and international commitments, electoral, audit, civil service and lawmaking functions; and b) public order and safety including various functions pertaining to law enforcement, maintenance of public order and safety and political administration. Expenditures for debt burden are those that go into the servicing of government's regular and assumed debts from domestic and foreign sources, including interest payments. 10. How are government expenditures categorized by cost structure? What is the significance of this categorization? The national government budget is broken down into the following cost categories: 1) general administration and support; 2) support to operations, and 3) projects. Expenditures for general administration represent those that are normally considered as agency overhead (i.e. the cost of general supervision) which the agency will incur to exist as a unit. Examples of expenditures for general administration and support are those spent for general management and supervision, human resources development, and for productivity incentive benefits. Support to operations refers to those activities that facilitate the performance of the agency's mandated functions and services. Examples of expenditures under this category are those that are meant for policy formulation and planning services; for program/project coordination, monitoring and evaluation; and for information management support system. Expenditures for operations are those that go to regular activities directly addressing the agency's mandates. They include expenditures for programs involving the production of goods; delivery of public services; regulation of societal activities; conduct of basic governance; or provision of general management and supervision of the entire government bureaucracy. Project expenditures are those that fund activities which result in the accomplishment of identifiable outputs within a designated period. Project expenditures may be sourced from foreign assistance or from local funding. The categorization of the budget by functional cost components allows for a better analysis of government expenditures to focus on more priority needs thus improving the quality of government spending. Capital Outlays of the National Government

27. Infrastructure expenditures refer to the disbursement of funds for the construction of various basic public works of the country, such as roads, ports, airports, water supply, irrigation, and other capital investments, the benefits of which extend to the general public. In the national budget, infrastructure expenditures generally refer to the capital outlays of the Department of Public Works and Highways and the Department of Transportation and Communication, the School Building Program of the Department of Education, Culture and Sports, and the national irrigation projects of the Department of Agriculture. 5. What constitute the other capital outlays of the government? The other capital outlays of the government consist of land acquisition and land improvement outlays, buildings and structures outlays, acquisition of vehicles, aircraft, water transport vehicles, equipment, furniture, fixtures, etc. 6. What are capital transfers to local government units (LGUs)? Capital transfers to local government units (LGUs) pertain to the portion of the Internal Revenue Allotment (IRA) which accrue to LGUs equivalent to not less than twenty percent (20%) of their IRA allocations, earmarked for development projects such as the construction/improvement, repair and maintenance of local roads, concrete barangay roads/multi-purpose pavements, and the rehabilitation and improvement of communal irrigation projects/systems. 7. What are the equity contributions to government corporations? Equity contributions to government corporations refer to the national government investments in the authorized capital stock of government-owned or controlled corporations. 8. What are interest payments? Interest payments represent the cost of borrowed funds which form part and parcel of the cost of the items financed by the loan. Interest payments are, therefore, considered as the real expense item in the budget. 9. How is the national government budget sectorally allocated? The national government budget is allocated according to the following major sectors: social services, economic services, defense, general public services, and debt burden. Allocation for social services include those for: a) education, culture and manpower development; b) health services; c) social security, welfare, and employment; d) housing and community development; and, e) land distribution. Provision for economic services include those for: a) communications, roads and transportation facilities; b) agriculture, agrarian reform and natural resources; c) water resources development and flood control; d) trade and industry; e) power and energy; and f) tourism. Expenditures for defense include those that support the general effort to ensure national security, stability and peace which are indispensable to economic growth and development. General public services expenditures are those that are spent for: a) general administration such as general government stipulation fiscal affairs, foreign affairs and international commitments, electoral, audit, civil service and lawmaking functions; and b) public order and safety including various functions pertaining to law enforcement, maintenance of public order and safety and political administration. Expenditures for debt burden are those that go into the servicing of government's regular and assumed debts from domestic and foreign sources, including interest payments. 10. How are government expenditures categorized by cost structure? What is the significance of this categorization? The national government budget is broken down into the following cost categories: 1) general administration and support; 2) support to operations, and 3) projects. Expenditures for general administration represent those that are normally considered as agency overhead (i.e. the cost of general supervision) which the agency will incur to exist as a unit. Examples of expenditures for general administration and support are those spent for general management and supervision, human resources development, and for productivity incentive benefits. Support to operations refers to those activities that facilitate the performance of the agency's mandated functions and services. Examples of expenditures under this category are those that are meant for policy formulation and planning services; for program/project coordination, monitoring and evaluation; and for information management support system. Expenditures for operations are those that go to regular activities directly addressing the agency's mandates. They include expenditures for programs involving the production of goods; delivery of public services; regulation of societal activities; conduct of basic governance; or provision of general management and supervision of the entire government bureaucracy. Project expenditures are those that fund activities which result in the accomplishment of identifiable outputs within a designated period. Project expenditures may be sourced from foreign assistance or from local funding. The categorization of the budget by functional cost components allows for a better analysis of government expenditures to focus on more priority needs thus improving the quality of government spending. Infrastructure Expenditures

28. Capital transfers to local government units (LGUs) pertain to the portion of the Internal Revenue Allotment (IRA) which accrue to LGUs equivalent to not less than twenty percent (20%) of their IRA allocations, earmarked for development projects such as the construction/improvement, repair and maintenance of local roads, concrete barangay roads/multi-purpose pavements, and the rehabilitation and improvement of communal irrigation projects/systems. 7. What are the equity contributions to government corporations? Equity contributions to government corporations refer to the national government investments in the authorized capital stock of government-owned or controlled corporations. 8. What are interest payments? Interest payments represent the cost of borrowed funds which form part and parcel of the cost of the items financed by the loan. Interest payments are, therefore, considered as the real expense item in the budget. 9. How is the national government budget sectorally allocated? The national government budget is allocated according to the following major sectors: social services, economic services, defense, general public services, and debt burden. Allocation for social services include those for: a) education, culture and manpower development; b) health services; c) social security, welfare, and employment; d) housing and community development; and, e) land distribution. Provision for economic services include those for: a) communications, roads and transportation facilities; b) agriculture, agrarian reform and natural resources; c) water resources development and flood control; d) trade and industry; e) power and energy; and f) tourism. Expenditures for defense include those that support the general effort to ensure national security, stability and peace which are indispensable to economic growth and development. General public services expenditures are those that are spent for: a) general administration such as general government stipulation fiscal affairs, foreign affairs and international commitments, electoral, audit, civil service and lawmaking functions; and b) public order and safety including various functions pertaining to law enforcement, maintenance of public order and safety and political administration. Expenditures for debt burden are those that go into the servicing of government's regular and assumed debts from domestic and foreign sources, including interest payments. 10. How are government expenditures categorized by cost structure? What is the significance of this categorization? The national government budget is broken down into the following cost categories: 1) general administration and support; 2) support to operations, and 3) projects. Expenditures for general administration represent those that are normally considered as agency overhead (i.e. the cost of general supervision) which the agency will incur to exist as a unit. Examples of expenditures for general administration and support are those spent for general management and supervision, human resources development, and for productivity incentive benefits. Support to operations refers to those activities that facilitate the performance of the agency's mandated functions and services. Examples of expenditures under this category are those that are meant for policy formulation and planning services; for program/project coordination, monitoring and evaluation; and for information management support system. Expenditures for operations are those that go to regular activities directly addressing the agency's mandates. They include expenditures for programs involving the production of goods; delivery of public services; regulation of societal activities; conduct of basic governance; or provision of general management and supervision of the entire government bureaucracy. Project expenditures are those that fund activities which result in the accomplishment of identifiable outputs within a designated period. Project expenditures may be sourced from foreign assistance or from local funding. The categorization of the budget by functional cost components allows for a better analysis of government expenditures to focus on more priority needs thus improving the quality of government spending. Capital Transfers to Local Government Units (LGUs)?

29. Financial analysis is the process of identifying the financial strengths and weaknesses of the firm by properly establishing relationships between the item of the balance sheet and profit & loss account. FINANCIAL ANALYSIS

30. Provide reliable financial information. Provide other needed information about changes in economic resources and obligation. Provide reliable information about changes in net resources. Providing financial information that assess in estimating the earnings of a business. To disclose other information according to the needs of the users. FINANCIAL ANALYSIS NEEDS

31. Helpful in assessing the financial position and profitability of a concern. To asses the present and future earning capacity of the concern. To assess the operational efficiency of the concern as a whole and of its various parts or departments. To assess the short term and long term solvency of the concern for the benefit of the debenture holders and trade creditors. FINANCIAL ANALYSIS OBJECTIVES

32. On the basis of material used, - External and internal analysis On the basis of modus operandi, - Horizontal and vertical analysis On the basis of Entities involved - Cross sectional and Time series On the basis of time horizon - Short term and long term analysis FINANCIAL ANALYSIS TYPES

33. Mislead the user Not useful for Planning It does not provide qualitative aspects. Comparison is not always possible. Wrong judgement. Subject to fraud. FINANCIAL ANALYSIS LIMITATIONS

34. REFERENCES: Peterson, P. P., & Fabozzi , F. J. (2002). Capital budgeting: theory and practice (Vol. 10). John Wiley & Sons. https://www.linkedin.com/pulse/capital-budgeting-techniques-importance-significance-manish-yadav/