The Business Cycle

By 
Dr Rebecca De Coster

RECAP
 Records results for external users 
Financial
 Highly regulated with accounting standards
Accounting
 Independently audited

 Historic results or estimates for internal users 
Management  Not regulated – report is formatted as needed
Accounting  Produced as needed 

rebecca.decoster@brunel.ac.uk 1
 The Business Cycle
New  Capital 
‐ Debt & Equity
funding
Retained 
Earnings (RE)
Dividend  Net Profit Assets
payments

Sales 
Revenues
Funders Enterprise

Consider (as an Engineering Manager) ….

To what extent is “profitability” 
important as an objective?

Be prepared to share your answers with the class

rebecca.decoster@brunel.ac.uk 2
 What is 'Agency Theory‘?
It concerns “the relationship between principals and 
agents in business” (investopedia.com)
“Agency theory is concerned with resolving 
problems that can exist in agency 
relationships due to unaligned goals or 
different aversion levels to risk. The most 
common agency relationship in finance 
occurs between shareholders (principal) and 
company executives (agents)”

Example: 
Company objectives
For a successful business?
Sufficient Revenues
• Customer base
• Desirable goods
• Competitive products/services
• Good customer service

Current potential (people with talent)
Future potential (innovation projects)
Financially healthy  (sufficient Cash!)

rebecca.decoster@brunel.ac.uk 3
 SUPPLIERS (CREDITORS) CUSTOMERS (DEBTORS)
Monies due out ‘Account  Sales due in ‘Account 
Payables’ (A/P) Receivables’ (A/R)
Finished 
WIP: Goods:

Materials
Cash from Sales

Cash $$s

Where,
WIP is ‘Work‐in‐Progress’ and refers to the items part way through production

Terminology

PARTIES MONETARY AMOUNTS
• SUPPLIERS • MONIES due to SUPPLIERS
• known as ‘CREDITORS’ • known as ‘ACCOUNTS PAYABLES (A/P)’
• or Trade Payables
• CUSTOMERS 
• known as ‘DEBTORS’ • MONIES due from CUSTOMERS 
• known as ‘ACCOUNTS RECEIVABLES (A/R)’
• or Trade Receivables

rebecca.decoster@brunel.ac.uk 4
 Example
A firm needs to manage its cash flow and this starts by taking 
information on expected sales and preparing cash flow 
forecasts based on this.
• Cash sales are 25% of monthly sales, and credit sales are 
collected 40% in the month after sales and 60% in the 
second month after sale.

• If expected sales are £100,000 when will the cash come in?

Case Study Example 
The sales forecasts of Alton Ltd for 
the first six months are: Sales forecasts
January £50k April £68k
1) How much cash will be collected 
from customers in April and May? February £60k May £84k
2) What are the budgeted Debtors at  March £54k June £74k
May 31 & June 30?

Where, Cash sales are 25% of monthly sales, and credit sales are collected 
40% in the month after sales and 60% in the second month after sale

rebecca.decoster@brunel.ac.uk 5
 A statement of financial position

Balance Sheet

‘Current’

Long‐term Enterprise Resources
‘ASSETS’ (WHAT IT OWNS)
• from Creditors (Trade & others)
• Split by time 
• from Owners (Stockholders) vs ‘LIABILITIES’
<1 year or longer • Retained Profit (or Earnings, RE) (WHAT IT OWES)
‐ the ‘CLAIMS’

Example: Assets vs Claims Assets (£) Claims (£)

At Start-up: Where, OF is Owners Funds Fixed Asset OF
Assets (£) Claims (£) Cash Payables
Cash         30,000 OF 20,000 
Bank loan    10,000 Assets (£) Claims (£)
Fixed Asset OF
You start a printing firm with £20,000 of your Profit (RE)
own money and a bank loan of £10,000:
Cash Payables
1) You buy a 3-D printer costing £18,000
2) You gain cash of £7,000 Assets (£) Claims (£)
3) Inventory of £5,000 is purchased on credit Fixed Asset OF
Inventory Profit (RE)
4) Half the inventory is sold on credit for £4,000
5) The firm pays £1,200 for staff & utilities
Receivables Payables
Cash

rebecca.decoster@brunel.ac.uk 6
 Types of funding

Capital Employed (CE) refers to the 
funds invested in a firm on a long‐
term basis for the purpose of funding 
assets to use in the business

• DEBT financing
• EQUITY financing

Funding types & costs

EQUITY DEBT
£70,000 £30,000
kE of 20% kD of 8%

Annual cost to firm:
£14,000 £2,400
Average cost (of capital):
£16,400 = 16.4%
£100,000

rebecca.decoster@brunel.ac.uk 7
 Consider …
Crowd funding
• Who has “control”?

What is the ‘Cost of Capital’?
Note: Tax rate is 30%
Funding Source Amount Cost of funding
Equity £500,000 12%
Bonds £140,000 9%
Overdraft £10,000 15%

Weighted Average Cost Of Capital

= [After‐tax cost of debt] x [%Debt financing]
WACC
+ [Cost of equity] x [%Equity financing]

rebecca.decoster@brunel.ac.uk 8
 Recording profitability
TRADING
PERIOD
• Expenses are the costs incurred 
in the process of converting the 
Profitability is determined by  input into an output. It involves 
the company’s income and  all the activities of the business 
expenses: • For example, rents and bills are 
• Income is money generated  considered to be business 
from the activities of the  expenses
business
• For example, when goods are 
produced and sold, income is 
generated

Causes of business failure?
• About one‐fifth of business start‐ups fail in the 
first year and about half of all employer 
establishments fail within five years. Only 
about one third survive ten years or more
Small Business Administration (SBA), 2017

rebecca.decoster@brunel.ac.uk 9
 Investors’ objectives

They view a firm as an ‘economic entity’
‐ a broader view

If we invest:
what ‘Return’ do we get?

What ‘Return’?

‘Return’ (on an investment)
• measures a firm’s performance  Return on Equity (ROE)
in using the resources to  • this measure of profitability links 
generate net income (profit)  net income to the portion of the 
firm’s assets that shareholders 
Example: have financed
For a savings account: Return On (Total) Assets (ROTA)
• ROI =   Interest        x 100% • measures a firm’s performance in 
Capital invested using assets to create net income 

rebecca.decoster@brunel.ac.uk 10
 Measures of profitability
Accounting Profit Economic Profit
Sales Revenues  Also deducts Opportunity costs
less
Expenses Where,
. Opportunity cost is the revenue that could 
‐ This represents  be achieved by utilising maximum labour
business’ capability
Example: the Cost of Capital Employed

Cost of Capital 
= Capital Employed multiplied by the ‘Cost of capital’
Employed

Performance analysis
• Profitability measures such 
as Economic Profit can be 
applied to assess different 
levels of investment

Economic Value Add (EVA)?

Economic Profit = (ROI  ‐ WACC)  x  Invested Capital

Where, ROI is the ‘Return’ on investment

‘Excess Return’ is the amount by which the Return exceeds (is greater than) WACC

rebecca.decoster@brunel.ac.uk 11
 To grow a business….

• Choose innovation projects 
where: 
Project ‘Return’ > Cost of Capital

…. As part of our philosophy of ‘Value Creation’

The course materials are 
organised into 5 sections:
1. Value Creation
2. The Flow of Materials 
3. Company Accounts 
4. Innovation and NPD 
5. Business Development

Course Materials are available online

rebecca.decoster@brunel.ac.uk 12