1. ARR is the annual measurement (in percentage) of how much an initial investment earns each year over a period of time. You’re essentially looking at how much profit each year, you’re going to earn if you choose to make that first investment. So if you have someone presenting a potential project to you that has a 15% ARR and another project that has an 8% ARR, you’re going to choose the first project. In the excel spreadsheets, the calculations are done for you using the function capabilities. However, for those of you interested in the math equation for calculating ARR, here we go!
ARR=(Avg Cash Inflows per Year – Annual Depreciation)/Initial Investment
As mentioned on this week’s Lessons tab, the first step to understanding your ARR, is knowing your rate of Depreciation. You calculate your Depreciation by subtracting the salvage value of an item from it’s original cost and then dividing by the years of use for the item: (Cost – Salvage Value)/Life in years.
Now how do you determine salvage value? Oftentimes one of two options are chosen. Either research is done to estimate the salvage value of an item, or a company may just assume the item will be worth nothing at the end of it’s life and use 0 as the Salvage Value. Look at Salvage value is similar to getting the blue book value on your car.
So why do this…why look for ARR? Again, as we’ve been learning, we want to make the best initial investment that will optimize the return of investment over time, and this is one of those methods.
Any questions or comments?
2. The Payback Rule
This method of assessing an investment basically looks at how soon the investment will pay for itself. In looking at the example given to us related to the financial crisis in 2008, we are told that as lending became restricted, companies placed more restrictions on payback periods for various investments.
If you were advocating for funding for a specific project or major purchase, how could this focus change from acquiring assets to building liquidity, impact the focus of your forecasting? ie…would you be forced to show a shorter payback period or be forced to provide more support for your arguments that a longer payback period would be worth the investment? There are no wrong answers here.
3. We’re learning about 3 different budget approaches in our reading assignment this week:
1. Incremental Budgeting
2. Zero Based Budgeting
3. Activity Based Budgeting
I’m very familiar with what the author discusses regarding the mass spending at the end of the calendar year or the fiscal year. In fact, many initiatives are funded on such a short term basis, that if the money isn’t spent at the end of the year, there is not guarantee that money can be carried over. This, in my opinion, instills bad budgeting habits. It’s short sighted and it can cause waste, as people are apt to spend money frivolously.
What are some advantages and disadvantages of Incremental Budgeting?
4. Let’s use your post to examine the analysis that goes into developing a budget using a SWOT analysis approach. I’ll start
Strengths: Looking at the current financial position of a company can help. Perhaps there is a slush fun, or the Accounts Receivables are at an acceptable level to where liquidity may not be a problem.
Weaknesses: Maybe costs are overrun? Perhaps there is excess spending in certain operational departments to where different areas are running into budget shortfalls, and we need to understand why.
Opportunities: Are there new products to launch, long term assets there may be opportunities to purchase that will grow in value
Threats: Are there business threats coming from competitors, regulatory requirements, etc
Any thoughts? Any others?
Each answer needs to have at least 100 words, and no formatting is required.
