Finance for NF managersi 2012

Review of Basic Terms
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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 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)

$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
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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
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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
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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 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 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
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 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%

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

0.57176

0.48225

0.40485

5

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

2

20,000

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

0.57176

0.48225

0.40485

5

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

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

2.85498

2.58873

2.34634

5

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