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

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

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 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

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

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

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

Finance for Non-Financial

Managers I

Repair or Replace

Finance for Non-Financial

Managers I