1. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 1 Understanding the Financial Statements

2. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 2 of 52 Chapter 13 Understanding Financial Statements  Accounting: The Basis of Decision- Making  Financial Statements: Financial Status for Businesses  Financial Ratios: Using Ratios to Make Business Decisions

3. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 3 of 52 Chapter Opening Story – WorldCom’s False Reporting Accounting Rule Says: Operating expenses should be expensed during the year they incur. What WorldCom Did: Operating expenses are capitalized by spreading them over 7 years, just like capital expenditure.

4. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 4 of 52 Result: WorldCom Reports “Profit” instead of “Loss”

5. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 5 of 52 A. Why Engineers need to understand the financial statements?

6. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 6 of 52 Accounting – The Language of Business

7. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 7 of 52 Financial Status for Business

8. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 8 of 52 B. Understanding the Balance Sheet 1.The basic accounting equation and the definition of capital 2.How to instantly determine liquidity and too much debt 3.How the firm gets equity: only two ways

9. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 9 of 52 The Basic Accounting Equation For the Balance Sheet Presentation For the Financial Analysis Assets - Liabilities = Owners’ Equity Assets = Liabilities + Owners’ Equity

10. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 10 of 52 How Items Are Arranged on the Balance Sheet Assets Liabilities Owners’ Equity

11. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 11 of 52 Using the Four Quadrants of the Balance Sheet and Why? ASSETSLIABILITIES Current Assets Long-Term Assets Current Liabilities Long-Term Liabilities Equity = 1.Owner Contributions 2.Retained Earnings

12. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 12 of 52

13. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 13 of 52 How to Instantly Determine Liquidity and Too Much Debt Liquidity Too Much Debt? Current Ratio (2:1) Debt To Equity Ratio

14. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 14 of 52 Liquidity – Current Ratio ASSETSLIABILITIES Current Assets Long-Term Assets Current Liabilities Long-Term Liabilities Equity 1.Owner Contributions 2.Retained Earnings

15. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 15 of 52 Too Much Debt? – Debt to Equity Ratio ASSETSLIABILITIES Current Assets Long-Term Assets Current Liabilities Long-Term Liabilities Equity 1.Owner Contributions 2.Retained Earnings Debt

16. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 16 of 52 How the Firm Gets Equity: Only Two Ways Owners’ Contributions Retained Earnings

17. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 17 of 52 1.How to Use profit check points 2.Why gross margin is the critical measure for engineers? 3.How does inventory production impact profit? C. Using the Income Statement to Manage a Business

18. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 18 of 52 Basic Income Statement Equation Revenue Expenses Net Income (Loss) -

19. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 19 of 52 Why Gross Margin is the Critical Measure for Engineers? Sales Cost of Goods Sold Gross Margin

20. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 20 of 52 How Inventory Production Impacts Profit Calculating the Cost of Goods Sold Beginning Inventory + Additions to Inventory - Ending Inventory Cost of Goods Sold

21. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 21 of 52 How to Use Profit Check Points ABC Company, Inc. Statement of Operations (Year Ended December 31, 200x) Sales$5,000,000100.0% Less: Cost of Goods Sold3,250,00065.0% Gross Profit1,750,00035.0% Less: Selling, G&A Expenses1,000,00020.0% Operating Profit750,00015.0% Less: Interest250,0005.0% Net Income Before Taxes (NIBT)500,00010.0% Less: Taxes175,0003.5% Net Income$325,0006.5% Bottom line

22. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 22 of 52

23. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 23 of 52 Operating Margin versus Net Margin Net margin Operating margin

24. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 24 of 52 D. Understanding the Statement of Cash Flows

25. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 25 of 52 1.The business operating cycle: How a business earns its cash 2.Sources and Uses of Cash 3.The engineer’s focus on the investing section: Capital Budgeting

26. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 26 of 52 Shareholders Fixed Assets Debt holders Inventory Government Customers CASH From cash sales To pay taxes From credit sales To pay labor, materials, and overhead To pay interest and principal From sale of debt To purchase From sale To pay dividend, To purchase back shares From sale of shares

27. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 27 of 52 The Cash Flow – Business Cycle Inventory Production Cash Accounts receivable Fixed assets Cash Sales Credit Sales Collection of receivable Investment Depreciation Changes in equity Changes in liabilities Pay taxes Pay interest Pay dividends Labor Materials Overhead

28. www.izmirekonomi.edu.tr Asst. Prof. Dr. Mahmut Ali GÖKÇE, Izmir University of Economics Spring, 2007 (c) 2001 Contemporary Engineering Economics 28 of 52