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UCSD LAMP 2014: Financial Success

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1 UCSD LAMP 2014: Financial Success
Dan Goldzband, CMA University of California, San Diego, Extension Division General Dynamics Global Imaging Systems, San Diego CA * All opinions expressed are the soley the presenter’s and do not represent the positions or policies of General Dynamics or the University of California.

2 Dan Goldzband, CMA Contact Info Cell: LinkedIn:

3 Financial Success Overview: Purpose
General: Provide a useful understanding of the basis of accounting and finance and how R&D fits into that schema; Enable you to communicate more effectively with your company’s financial managers and staff, for your mutual benefit. Specific: Provide tools to track and analyze your own LAMP project’s performance.

4 Financial Success Overview: Presentation Outline
Underlying concepts: finance vs. accounting Nature and analysis of costs Projecting project development cost / Using the Budget & Costing Template Exercise: Set up Budget & Costing Template Evaluating future project or product financial performance Exercises: Project your team project’s financial performance Southwest Airlines landing system

5 Financial Success Overview: Presentation Outline (part 2)
Evaluating company financial performance Review Cohu, Inc. financial statements Select companies for more rigorous financial statement analysis at 2nd meeting R&D case studies: Assignment: R&D case studies to report at 2nd meeting Case Exercise: Gold Peak Electronics (if time permits)

6 Company Performance Simulation Exercise

7 Underlying Concepts: Finance vs. Accounting

8 Finance vs. Accounting (dueling definitions)
Finance: Science of market valuation Financial management: Area of management where decisions are based primarily on considerations of value. Accounting: Information system used to collect and organize data and provide information regarding an entity’s financial performance and condition.

9 Finance vs. Accounting (basic work products)
Accounting: financial statements and various performance analyses derived from them (historical): Income statement Balance sheet Cash flow statement Finance: performance projections and valuations (future-oriented): Cash flow projections NPV / Economic value added analysis

10 Nature and Analysis of Costs

11 Cost Definitions -- Part 1
Cost: The amount of resources surrendered (or obligations incurred) to acquire or create a new resource. Expense: Amount of resources consumed to deliver goods/services to customers, or carry out the company’s major or central operations (i.e. use of either existing assets or new resources) Note: Costs are recognized as expenses only when the resources they represent are actually consumed. Only then can the costs be matched as expenses against revenues (directly or indirectly) and thus permit calculation of performance (accomplishments – efforts).

12 Cost Analysis concepts
Cost Object: Anything about which cost data is collected; the point of reference of cost measurement. Cost Driver: Any independent factor (variable) that causes costs to be generated.

13 Cost Classifications (non-exclusive)
Classification Basis Product costs vs. period costs Relationship to revenue generation Direct vs. indirect Relationship to occurrence of specified activity Cost behavior: Variable vs. fixed Relationship to volume of activity

14 Product Costs: accounting treatments according to product character
Tangible product: Product in form of finished goods inventory until actually sold (i.e., reclassified from a cost to an expense) Examples: Delta Design (Cohu) test handlers, kits and spare parts GD GIT motors, resolvers and other devices HP printers Services: Product in form of service, series of services or other intangible. Cost of providing these services or intangible benefits is expensed as incurred, regardless of how much (or little) revenue results in same period. Examples: AT&T communication services Google web-based advertising Southwest Airlines transport services

15 Period Costs Definition: Costs not related to production activities. These usually occur as a function of the passage of time, or at least independently of fundamental production or operational activities. Typical period costs: Selling costs (advertising, commissions, delivery, support) General and administrative costs R&D Note: What is the fundamental activity of any company?

16 Product Costs: analysis
Definition: Costs pertaining to the creation, acquisition or generation of the company’s product or services. Traditional manufacturing model of product costs: Raw materials + Direct labor + Overhead (includes depreciation*) = Product cost * Depreciation of production capital assets

17 Product vs. Period Costs (standard P&L format)

18 Direct vs. Indirect Costs
Traditionally applies specifically to product costs Definitions: Direct costs: Product costs which can be related or traced to specific, discrete units of production or services. Indirect costs: Product costs which cannot be related or traced to specific, discrete units of production or services, or for which it is impractical to do so.

19 Direct vs. Indirect Costs (with production as cost driver)

20 Cost Behavior Patterns
Variable costs: Vary in relation (usually directly) to the volume of a specific activity/cost driver (usually production or sales) Fixed costs: Do not vary directly as a function of same activity. (“Fixed” actually a misnomer—theses costs do vary, but are not driven by—are not a function of—production or sales).

21 Fixed vs. Variable Costs (contribution margin format P&L)

22 Specific Cost Classifications

23 Specific Cost Classifications

24 Product Costing Tools Bill of Materials (BOM) Routing

25 Costed Bill of Material

26 Costed Labor Routing (and full cost summary)
Operation Description Hours Cost/Hr. Ext. Cost 10 Assemble 2.50 $25.00 $62.50 20 Test 1.00 45.00 30 Move to stock 0.25 25.00 6.25 3.75 $113.75 Material cost 2,020.00 Total unit cost $2,133.75

27 Key Cost Accounting/Mgt Terms
Standard cost: Pre-determined, per-unit cost for a component of production or service (material, labor or OH). Used in internal control process as benchmark standard. Cost variance: Amount of difference between actual and standard cost. Target costing: The process of setting product cost goals at or near start of product development process and designing products to meet those cost goals.

28 III. Projecting Project Development Cost

29 Evaluating Financial Performance
Project cost evaluation: Development cost vs budget Achieving product target cost Financial contribution evaluation: NPV ROI Payback

30 Project Development Costs
Materials and Services: Materials Purchased services (consulting) Labor (at burdened rates): R&D Overhead

31 LAMP Project Financial Management Tool: Budget and Costing Template
Collect and report project development costs by period Project 12 months net income and calculate projected Return on Investment

32 IV. Evaluating Future Project or Product Financial Performance

33 Evaluating Product Financial Performance
Payback Return on Investment (ROI) Net Present Value (NPV, aka Economic Value Added, or EVA)

34 Project 1: Sample Assumptions
Investment ,000 P&L / Cash Flow: $ / unit Qty Ext Revenue , ,500,000 Variable cost , (1,000,000) Contribution Margin ,500,000 Fixed Costs (excl Depreciation) (1,000,000) Depreciation (150,000) Op Profit ,000 35% (122,500) Net Income ,500 Plus: Depreciation (non-cash expense) ,000 Annual Cash Flow ,500 5-year economic life, discount rate: 12%

35 Timing of Product Financial Evaluations
At project inception vs Upon project completion

36 Payback Criteria: Time required to recover investment Calculation:
Investment / annual cash flow Scenario 1 Payback: 750,000 / 377,500 = 2 years

37 Return on Investment (ROI)
Criteria: Financial return Calculation: Annual cash flow / Investment Project 1 ROI: 377,500 / 750,000 = 51%

38 Net Present Value (NPV)
Criteria: Value added from final product. Calculation: Sum of present values of cash flows (negative and positive) Project 1 Incremental Value: Investment (750,000) PV of Op C/F’s ,360,803 NPV ,803

39 Relative Merits Payback: Critical to capital management
ROI: Ease of understanding and applicable to post-investment performance evaluation NPV: Directly addresses fundamental issue of shareholder value

40 Relative Disadvantages
Payback: Disregards time value of money and actual value created ROI: Disregards time value of money and actual value created NPV: Best used as investment decision rule, not well-suited for post-hoc analysis

41 Project 2: Sample Assumptions
Investment ,500,000 P&L / Cash Flow: $ / unit Qty Ext Revenue , ,750,000 Variable cost , (1,000,000) Contribution Margin ,750,000 Fixed Costs (excl Depreciation) (1,000,000) Depreciation (150,000) Op Profit ,000 35% (210,000) Net Income ,000 Plus: Depreciation (non-cash expense) ,000 Annual Cash Flow ,000 7-year economic life, discount rate: 12%

42 Payback (Project 2) Criteria: Time required to recover investment
Calculation: Investment / Annual cash flow Scenario 1 Payback: 1,500,000 / 540,000 = 2.78 years

43 Return on Investment (ROI) (Project 2)
Criteria: Financial return Calculation: Annual cash flow / Investment Scenario 1 ROI: 540,000 / 1,500,000 = 36%

44 Net Present Value (NPV) (Project 2)
Criteria: Value added Calculation: Sum of present values of cash flows Scenario 1 Incremental Value: Investment (1,500,000) PV of Op C/F’s 2,464,429 NPV ,429

45 Comparison of Methods and Results
Project 1 Project 2 Payback yrs yrs ROI 50% % NPV , ,429

46 Assignment (right now!)
Project your project’s ROI Payback (Suggest you add to final report, refining the estimates as necessary)

47 Group Exercise Read WSJ article: “A Radical Cockpit Upgrade Southwest Fliers Will Feel” List every conceivable (and plausible) investment, expenditure or operational change that Southwest will have to make to implement and maintain this system (the negative cash flows in an NPV analysis). Also list any non-obvious possible positive cash flows or benefits.

48 V. Evaluating Company Financial Performance

49 There are only four things that happen in baseball:
You throw the ball, You hit the ball, You catch the ball And you run.

50 Only Four Things Happen in Finance (with apologies to Bull Durham)
You raise capital (from investors) You invest capital (in capital assets or product development) You return capital (to the investors) You restructure capital (debt for equity, or vice versa)

51 Capital Cycle: Presentation in Financial Statements
Source of capital: Investors Repayment of & return on investment (principle, interest , dividends & stock buy-backs) Equity / debt investment in venture Cash Flow Statement: Financing Section Investing Section (CAPEX only) Financing Positive operating C/F (we hope!) Income Statement / Profit and Loss (P&L) Operations (utilizing capital assets or developed IP) Investment (in capital assets, or product development for tech/bio ventures) Cash Flow Statement: Operations Section

52 Basic Financial Statements
Profit and Loss Statement / Income Statement Summarizes historic economic/financial performance Always 3 years comparative statements Cash Flow Statement Categorizes and presents all cash flows Balance Sheet Summarizes all financial resources and obligations/ claims against assets to arrive at accounting of enterprise value Always 2 years comparative statements

53 Basic Financial Statements
Owners’ Equity Statement Summarizes transactions affecting shareholders’ interest in the company Always 3 years comparative statements Notes to Financial Statements

54 Basic Financial Statement Analysis: The Four Questions
What is the trend and quality of recent earnings performance? What are the trend and drivers of recent operating cash flow performance? How has the company been providing for / investing in its future, and how is it financing this investment? Assess the company’s financial condition and its financial strategy.

55 Financial Performance
Profitability: Ascertain profitability (net income and other interim income measurements) and trend (source: P&L/Income Statement) Cash Flow: Is the company generating a positive and increasing operating cash flow? (source: Cash Flow Statement, operating section)

56 Changes in Components of Financial Performance
Prepare and review P&L vertical analysis for the 3 years to identify trends and changes in performance drivers Identify reasons for changes in operating cash flow.

57 Extent of Investment in the Future
R&D as % of revenues (source: P&L) Capital expenditures (Cap X) in new productive assets and acquistions (source: Cash Flow Stmnt, Investing Section) Sum of R&D expense and Cap X, as % of revenues (combined “plowback ratio”) Revenue (the fundamental company activity) is the standard basis for performance benchmarking

58 Financial Strategy & Condition
Four financial activities: Raising capital (from investors) Investing capital Returning capital (to investors) Restructuring capital (usually to improve overall cost of capital) #1, 3 and 4 are the “3 R’s” which indicate a company’s overall financial relationship with respect to its investors—what is the net activity over the 3 years represented?

59 Clues to Financial Strategy & Condition
In C/F statement: Net financing C/F (positive, negative or neutral?) Dividends being paid? Stock repurchases? Debt activity (issuances, repayments or both?) In Balance Sheet: Change in $ amount of debt or equity Change in capital structure (debt/equity ratio)

60 Review of Cohu, Inc. F/S’s
Go to LAMP Holistic Financial Statement Analysis.

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