Finance for Non-Financial Managers I 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.

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 5. 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) Gross profit (margin) percentage ($600/$1,500) Markup percentage ($600/$900) $1,500 (900) $600 40% 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 Cost of Sales Cost of Goods Sold (COGS) Inventory Freight on Purchases 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 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 house1,139 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 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 1 hour$12 Benefit costs for the carpenter8 Lumber and glass65 Maintenance10 Electricity5 Total cash expenses$100 Depreciation expense15 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) $300 If Spouse House used the Automatic Window Machine, the cash expense would be (per house) 100 The amount saved per house$200 Multiplied by the number of house sold annuallyx 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% Use the “10%” column to determine if purchase of the Automatic Window Machine should be purchased: End of yr #Cash FlowFactorPresent Value 1$20, $18, , , , , , , , ,523 Total of present value78,919 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% 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: YearCash FlowFactorPresent Value 1$20, $15, , , , , , , , ,073 Total of Present Values$54,998

Finance for Non-Financial Managers I Time Value of Money (cont.) End of yr #10%15%20%25.365% 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 > %

Finance for Non-Financial Managers I Cash Flow from Purchase of Equipment

Finance for Non-Financial Managers I Repair or Replace