Review of Basic Terms • • • • • • • • Asset/liability: An asset is an economic resource that a company owns A liability is a resource that the company owes Book value/market value: Book value is the amount of an asset or liability shown on the companies’ official financial statements based on the historical, or original, cost Market value is the current value of the asset or liability In most cases, book value does not equal market value Capital goods: These are machines and tools used to produce other goods Depreciation/amortization: Depreciation is a system that spreads the cost of a tangible asset, such as machinery, over the useful life of the asset Amortization is a system that spreads the cost of an intangible asset, such as a patent, over the useful life of the asset Fiscal year: A company’s financial reporting year In most cases the fiscal year is not the same as the calendar year Profit margin: This is profit—what the company’s owners keep after paying all the bills—a percentage of sales or revenues Receivables/payables: Receivables are money owed to the company Payables are money the company owes to others Revenue/expenses: Revenue is income that flows into a company Revenue includes sales, interest, and rents Expenses are costs that are matched to a specific time period Finance for Non-Financial Managers I Managerial and Financial Accounting Managerial accounting provides information for managers of an organization who direct and control its operations Financial accounting provides information to stockholders, creditors and others who are outside the organization Finance for Non-Financial Managers I Cash vs Accrual Methods of Accounting January Expenses Rosie sells three Spouse Houses at $1,500 each, for cash She purchases the three Spouse Houses from Fred’s Sheds for $900 each She pays him for two of the Spouse Houses ($1,800) and promises to pay him for the third one on February She pays $800 for her office ($400 for January rent and $400 as a security deposit) She pays $150 to purchase a telephone and $30 for service during January She pays $300 for advertising in a newspaper On February 5, she receives an electric bill for electricity used in January for $100 She charges the January rent of the automobile ($280) to her credit card, which she does not pay until February 15 Finance for Non-Financial Managers I Cash Accounting Finance for Non-Financial Managers I Accrual Accounting Finance for Non-Financial Managers I Gross Profit (Margin) Selling price, each Spouse House Subtract cost of each Spouse House Gross profit (margin) $1,500 (900) $600 Gross profit (margin) percentage ($600/$1,500) 40% Markup percentage ($600/$900) 67% Finance for Non-Financial Managers I The Importance of Timing • Matching principle: The accrual method matches revenues with associated expenses • Timing: The accrual method records revenue that has been earned but not paid and expenses owed but not paid • Cash flow: The accrual method does not track cash inflows and outflows Finance for Non-Financial Managers I Types of Sales • • • • • • • Cash sales Credit sales Consignment (sale?) Secured sales Floor plan sales Sales of services Long-term contracts Finance for Non-Financial Managers I Reduction of Sales • • • • • Bad debts Sales returns Sales allowances Warranties Cash discounts Finance for Non-Financial Managers I Allowance for Bad Debt Finance for Non-Financial Managers I FIFO vs LIFO Finance for Non-Financial Managers I FIFO vs LIFO Finance for Non-Financial Managers I FIFO vs LIFO Finance for Non-Financial Managers I Average Cost Method Finance for Non-Financial Managers I Projected Sales Finance for Non-Financial Managers I Break Even Using the information from the previous slide, compute the variable cost per house: Each house sells for $1,500 Subtract variable cost per house 1,139 Contribution toward fixed expenses $361 Divide the fixed cost by the contribution margin to determine how many houses must be sold to break even $10,000/361 = 27.7 or 28 houses (since you can’t sell house) Finance for Non-Financial Managers I Maintenance and Depreciation Expense Finance for Non-Financial Managers I Payback Method Spouse House’s clients want three windows put in their houses Assume it costs $300 per house for the supplier to install the windows Spouse House could purchase an Automatic Window Machine that would cost $55,000 and would require the following expenses: Salary for a carpenter for hour Benefit costs for the carpenter $12 Lumber and glass 65 Maintenance 10 Electricity Total cash expenses $100 Depreciation expense 15 Total expenses $115 Finance for Non-Financial Managers I Payback Method (cont.) The computation of cash flow from the Automatic Window Machine from the previous slide is: If Spouse House used the service of the supplier to install the windows, it would cost (per house) If Spouse House used the Automatic Window Machine, the cash expense would be (per house) $300 100 The amount saved per house $200 Multiplied by the number of house sold annually x 100 Annual cash saved by purchasing the Automatic Window Machine $20,000 The payback, assuming no interest on a loan and $5,000 salvage value of the equipment would be 2.50 years ($50,000/$20,000) Finance for Non-Financial Managers I Time Value of Money Finance for Non-Financial Managers I Time Value of Money (cont.) End of yr # 10% 15% 20% 25.365% 0.90909 0.86975 0.83333 0.79767 0.82645 0.75615 0.69444 0.63628 0.75132 0.65752 0.57870 0.50754 0.68302 0.57176 0.48225 0.40485 0.62093 0.49718 0.40188 0.32294 Use the “10%” column to determine if purchase of the Automatic Window Machine should be purchased: End of yr # Cash Flow Factor Present Value $20,000 0.90909 $18,181 20,000 0.82645 16,529 20,000 0.75132 15,026 20,000 0.68302 13,660 25,000 0.62093 15,523 Total of present value 78,919 Since $78,919 is significantly greater than $55,000 the machine would be justified Finance for Non-Financial Managers I Time Value of Money (cont.) End of yr # 10% 15% 20% 25.365% 0.90909 0.86975 0.83333 0.79767 0.82645 0.75615 0.69444 0.63628 0.75132 0.65752 0.57870 0.50754 0.68302 0.57176 0.48225 0.40485 0.62093 0.49718 0.40188 0.32294 Using the above table to calculate the Internal Rate of Return on the $20,000 annual saving on a $55,000 investment with $5,000 salvage value: Year Cash Flow Factor $20,000 0.79767 $15,953 20,000 0.63628 12,725 20,000 0.50754 10,150 20,000 0.40485 8,097 25,000 0.32294 8,073 Total of Present Values Present Value $54,998 Finance for Non-Financial Managers I Time Value of Money (cont.) End of yr # 10% 15% 20% 25.365% 0.90909 0.86975 0.83333 0.79767 1.73554 1.62571 1.52778 1.43395 2.48685 2.28323 2.10648 1.94149 3.16987 2.85498 2.58873 2.34634 3.79079 3.35216 2.99061 2.66928 Using the above table to calculate the Internal Rate of Return on the $20,000 annual saving on a $55,000 investment with no salvage value: $20,000 x = $50,000 X = 2.50 x > 25.365% Finance for Non-Financial Managers I Cash Flow from Purchase of Equipment Finance for Non-Financial Managers I Repair or Replace Finance for Non-Financial Managers I [...]... Discounts Cost of Services Finance for Non-Financial Managers I Inventory Value • FIFO • LIFO • Average Cost Finance for Non-Financial Managers I FIFO vs LIFO Finance for Non-Financial Managers I FIFO vs LIFO Finance for Non-Financial Managers I FIFO vs LIFO Finance for Non-Financial Managers I Average Cost Method Finance for Non-Financial Managers I Projected Sales Finance for Non-Financial Managers... and Depreciation Expense Finance for Non-Financial Managers I Payback Method Spouse House’s clients want three windows put in their houses Assume it costs $300 per house for the supplier to install the windows Spouse House could purchase an Automatic Window Machine that would cost $55,000 and would require the following expenses: Salary for a carpenter for 1 hour Benefit costs for the carpenter $12 8... Rate of Return on the $20,000 annual saving on a $55,000 investment with no salvage value: $20,000 x = $50,000 X = 2.50 x > 25.365% Finance for Non-Financial Managers I Cash Flow from Purchase of Equipment Finance for Non-Financial Managers I Repair or Replace Finance for Non-Financial Managers I ... Break Even Using the information from the previous slide, compute the variable cost per house: Each house sells for $1,500 Subtract variable cost per house 1,139 Contribution toward fixed expenses $361 Divide the fixed cost by the contribution margin to determine how many houses must be sold to break even $10,000/361 = 27.7 or 28 houses (since you can’t sell 7 house) Finance for Non-Financial Managers... purchasing the Automatic Window Machine $20,000 The payback, assuming no interest on a loan and $5,000 salvage value of the equipment would be 2.50 years ($50,000/$20,000) Finance for Non-Financial Managers I Time Value of Money Finance for Non-Financial Managers I Time Value of Money (cont.) End of yr # 10% 15% 20% 25.365% 1 0.90909 0.86975 0.83333 0.79767 2 0.82645 0.75615 0.69444 0.63628 3 0.75132 0.65752... 0.82645 16,529 3 20,000 0.75132 15,026 4 20,000 0.68302 13,660 5 25,000 0.62093 15,523 Total of present value 78,919 Since $78,919 is significantly greater than $55,000 the machine would be justified Finance for Non-Financial Managers I Time Value of Money (cont.) End of yr # 10% 15% 20% 25.365% 1 0.90909 0.86975 0.83333 0.79767 2 0.82645 0.75615 0.69444 0.63628 3 0.75132 0.65752 0.57870 0.50754 4 0.68302... salvage value: Year Cash Flow Factor 1 $20,000 0.79767 $15,953 2 20,000 0.63628 12,725 3 20,000 0.50754 10,150 4 20,000 0.40485 8,097 5 25,000 0.32294 8,073 Total of Present Values Present Value $54,998 Finance for Non-Financial Managers I Time Value of Money (cont.) End of yr # 10% 15% 20% 25.365% 1 0.90909 0.86975 0.83333 0.79767 2 1.73554 1.62571 1.52778 1.43395 3 2.48685 2.28323 2.10648 1.94149 4 3.16987... expenses: Salary for a carpenter for 1 hour Benefit costs for the carpenter $12 8 Lumber and glass 65 Maintenance 10 Electricity 5 Total cash expenses $100 Depreciation expense 15 Total expenses $115 Finance for Non-Financial Managers I Payback Method (cont.) The computation of cash flow from the Automatic Window Machine from the previous slide is: If Spouse House used the service of the supplier to install