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 companys financial reporting year. In most cases the fiscal
year is not the same as the calendar year.
Profit margin: This is profitwhat the companys owners keep after
paying all the billsa 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 Freds 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
Basic Concept (Cash Accounting and Accrual Accounting)
Report Version 1 (Cash Basis)
January Report
Cash Receipts
Sale of 3 spouse houses
Cash Disbursements
Purchase of 2 spouse houses
Office deposit and rent
Telephone purchase
Telephone service
Advertising
Total Cash Disbursements
Excess of receipts over disbursements

Finance for Non-Financial

Managers I

$4,500
$1,800
800
150
30
300
$3,080
$1,420

Accrual Accounting
Basic Concept (Cash Accounting and Accrual Accounting)
Report Version 2 (Accrual Basis)
January Report
Revenues
Sale of 3 spouse houses
Less Cost of Good Sold (3 Spouse Houses @ $900 each)
Gross profit
Expenses
Office rent
$400
Telephone service
30
Automobile rent
280
Electricity
100
Advertising
300
Total Cash Disbursements
Excess of receipts over disbursements

Finance for Non-Financial

Managers I

$4,500
(2,700)
1,800

$1,110
$690

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

Year
1
2
3
4
5
6
7

Sales
$250,000
650,000
1,500,000
2,000,000
2,500,000
3,500,000
4,000,000

Bad Debt
Expenses Incurred
$10,000
26,000
60,000 $1,800
80,000
100,000
3,600
140,000
160,000 450,000

Finance for Non-Financial

Managers I

Accumulated
Allowance for
Bad Debt
$10,000.00
36,000.00
94,200.00
174,200.00
270,600.00
410,600.00
120,600.00

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

November--First In, First Out (FIFO)
Sales of 10 Spouse Houses @ $1,500
Subtract Cost of Goods Sold:
Inventory at beginning of November
(4 houses @ $900 each)
Purchase 15 houses @ $1,000 each
19 houses available for sale
Subtract remaining inventory:
9 houses (purchased in November)
@ $1,000 each
Cost of Spouse Houses sold
Gross profit

$
$

Finance for Non-Financial

Managers I

15,000

9,600
5,400

3,600
15,000
18,600

9,000

FIFO vs. LIFO

November--Last In, First Out (LIFO)
Sales of 10 Spouse Houses @ $1,500
Subtract Cost of Goods Sold:
Inventory at beginning of November
(4 houses @ $900 each)
Purchase 15 houses @ $1,000 each
19 houses available for sale
Subtract remaining inventory:
9 houses, 5 @ $1,000
4 @ $900 each
Cost of Spouse Houses sold
Gross profit

15,000

10,000
5,000

3,600
15,000
$ 18,600

Finance for Non-Financial

Managers I

5,000
3,600

FIFO vs. LIFO

Inventory
available
for sale
(at cost)

Purchased
in November

Purchased
in October

$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$

FIFO

1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
900
900
900
900

Total Inventory

LIFO

Left at end
of November (9)
$9,000

Sold during
November (10)
$10,000

Sold during
November (10)
$9,600

Left at end
of November (9)
$8,600

$18,600

$18,600

Finance for Non-Financial

Managers I

$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$
$

1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
1,000
900
900
900
900

Average Cost Method

November--Average Cost Method
Sales of 10 Spouse Houses @ $1,500
Subtract Cost of Goods Sold:
Inventory at beginning of November
(4 houses @ $900 each)
Purchase 15 houses @ $1,000 each
19 houses available for sale
Subtract remaining inventory:
9 houses @ $979
($18,600/19 = $979)
Cost of Spouse Houses sold
Gross profit

$
$

Finance for Non-Financial

Managers I

15,000

9,789
5,211

3,600
15,000
18,600

8,811

Projected Sales
Spouse House Company
Projection of Operating Report
March 2011
Projected Sales =
Sales of Spouse Houses
Variable Expenses
Cost of goods sold
Sales commissions
Delivery
Bad debt expense
Warranty expense
Liability insurance
Product liability insurance
Supplies, warehouse
Business license

20

$ 1,500 $

30

40

30,000 $ 45,000 $

60,000

18,000
1,500
1,000
1,200
600
73
153
93
153

27,000
2,250
1,500
1,800
900
110
230
140
230

36,000
3,000
2,000
2,400
1,200
147
307
187
307

22,773

34,160

45,547

2,000
1,500
2,000
2,000
430
110
100
1,000
30
130
550
150

2,000
1,500
2,000
2,000
430
110
100
1,000
30
130
550
150

2,000
1,500
2,000
2,000
430
110
100
1,000
30
130
550
150

Total fixed expenses

10,000

10,000

10,000

Total expenses

32,773

44,160

55,547

60.00%
5.00%
3.33%
4.00%
2.00%
0.24%
0.51%
0.31%
0.51%

Total variable expenses

Fixed Expenses
Executive salary
Administrative salaries
Warehouse and repair salaries
Advertising
Automobile
Worker's compensation insurance
Fire and casualty insurance
Rent
Supplies, office
Property taxes
Payroll taxes
Telephone

Net income (loss) before income tax

Income tax
Net income (loss)

(2,773) $

840 $

4,453

0
(2,773) $

210
630 $

1,113
3,340

Finance for Non-Financial

Managers I

Break Even
Using the information from the previous slide, compute the variable cost
Spouse House Company
per house:
Projection of Variable Expenses per Spouse House
March 2011

Projected Sales
Total variable expenses
$
Variable expense per house sold

20

30

40

22,773 $ 34,160 $ 45,547

1,139
1,139
1,139

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 cant sell .7 house).
Finance for Non-Financial
Managers I

Maintenance and Depreciation

Expense

Depreciation and Maintenance Costs-Straight Line

Depreciation and Maintenance-Accelerated

30

30
25

20
Maintenance

15

Depreciation

10

Thousands ($)

Thousands ($)

25

20
Maintenance

15

Depreciation
10
5

0
1

Year of equipm ent life

Year of equipment life

Finance for Non-Financial

Managers I

Payback Method
Spouse Houses 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

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

Interest earned on a $55,000 investment that can
earn 10% interest
Initial investment (present value)
Interest, first year
Balance, end of first year
Interest, second year
Balance, end of second year
Interest, third year
Balance, end of third year
Interest, fourth year
Balance, end of fourth year
Interest, fifth year
Balance, end of fifth year
or, using a future value table,

$ 55,000

$ 55,000
5,500
60,500
6,050
66,550
6,655
73,205
7,321
80,526
8,053
88,578
x

Finance for Non-Financial

Managers I

1.6105 =

$ 88,578

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
1

$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

Cash Flow from Purchase of Copy Machine
Existing cost (local printer)
$
Subtract cash expenses if copy
machine is purchased:
Paper
$
500
Maintenance
1,500
Supplies
300
Electricity
100
Machine operator
1,000
Total cash expense
Cash flow
$
Cost of machine
$
Payback period (machine cost cash flow) = 1.88 years

Finance for Non-Financial

Managers I

5,000

3,400
1,600
3,000

Repair or Replace
Cash Flow Analysis--Repair or Replace

Alternative cost (printer)

Subtract cash expenses:
Paper
Maintenance
Supplies
Electricity
Machine operator
Total cash expenses
Cash flow
Cost of machine
Payback, in years
Internal rate of return

New
Machine

Refurbish
Old

$ 5,000

$ 5,000

500
2,000
500
100
500
3,600
$ 1,400
$ 5,000
3.57
12.4%

500
1,750
500
100
1,000
3,850
$ 1,150
$ 2,800
2.43
30.0%

Finance for Non-Financial

Managers I