MGMT 497 Accounting/Finance Forecasting Sales, market share, etc. Operation Capacity (plant, addition, line), production (first shift, 2nd shift, overtime), sales office order, inventory control, etc. Human Resources Hiring, training, salary/commission, etc. Marketing Product management (pricing, product model, quality and feature), advertising, R&D, etc. Finance/Accounting Capital budgeting, capital structure (debt/equity), cash management, financial statements analysis, etc.

Finance related decisions Financing Internal capital (retained earnings) versus external capital (debt or equity) Debt (short-term bank loans or long-term bond issuance) Dividend policy Paying dividends to outside stockholders by parent company Capital budgeting or investment decisions Adding or closing new plant, adding or deactivating lines, etc.

Dos Forecast sales correctly Proper production capacity Good marketing strategies Sound financing decisions Good Industry analysis Cost and benefit analysis

Don’ts Avoid stock-out Avoid emergency loans due to negative cash balance Avoid drastic changes without valid reasons Avoid making decisions without considering costs and benefits

Business policy game performance measurement Return on assets (ROA) Return on equity (ROE) Market share Stock price Unit production cost Total net income

Weighing Factors 20 points to be allocated among six performance criteria At least five points given to ROA and ROE combined At least three points given to stock price At least two points given to total net income

Return on assets (ROA) Average net income years 3 thru 6 Average year end assets year 3 thru 6 Component ratios (determinants) Net profit margin (driven by expenses) Total asset turnover (driven by efficiency or sales generated by each dollar of assets)

Return on Equity (ROE) Average net income years 3 thru 6 Average year end equity years 3 thru 6 Component ratios (determinants) Net profit margin (driven by expenses) Total asset turnover (driven by efficiency or sales generated by each dollar of assets) Equity multiplier (driven by use of debt) At least five points given to ROA and ROE combined

Example of determinants of ROA and ROE Total revenue: 200 Net income: 6 Total assets:100 Equity:80 Debt:20 Net profit margin=6/200=3% Total asset turnover=200/100=2 Equity multiplier=100/80=1.25 ROA=3%x2=6% or 6/100=6% ROE=3%x2x1.25=7.5%% or 6/80=7.5%

Market Share Total company dollar sale years 3 thru 6 Total industry dollar sale years 3 thru 6 Company sales vs industry sales Pricing Advertising Sales force compensation Product model, quality, and feature

Stock Price Average year end stock price year 3 thru 6 Earnings Capital structure (debt vs equity) Credit rating Dividends paid At least 3 points

Examples of Factors affecting credit rating & stock price Avoid emergency loan Meeting debt obligation Growth of total assets Increasing market share Good ROE Paying dividends Avoid excessive debt financing Good interest coverage

Unit Production Cost Average unit production cost years 3 thru 6 Labor cost, material cost, maintenance cost, layoff cost, shutdown cost, equipment depreciation, plant depreciation Consider variable cost vs fixed cost

Total Net Income Sum of net income years 3 thru 6 Sales Cost of goods sold, operating expenses and non-operating expenses At least 2 points

Capital spending See page 153. New plant with 2, 4,… up to 10 lines Takes 3 quarters to complete For example, 4 line pant costs $1.9 million or $0.6 million a quarter (page 151), subject to inflation. New addition (2 lines) to existing plant Takes 2 quarters to complete Costs $0.9 million or $.45 million a quarter; inflation. New line Takes one quarter to complete $.5 million, plus hiring/training of new workers $.1 million per line.

Sources of capital See capital budget worksheet, page 167 Accumulated retained earnings Issue bonds Issue stocks 3-month bank loans Selling stocks to parent

Finance Decision Variables Bank loan Bond issue Stock issue Dividends Time Deposit CDs

Bank Loans $2.5 million line of credit available to parent Access to line of credit using 3-month bank loans by parent Bank loans cannot exceed 50% of the value of receivables and inventory of previous quarter. Bank loans are not available if there are bank loans outstanding during each of previous three quarters. Recommended for short-term financing only

Emergency Loans Not a decision variable Automaticaly given in case of insufficient funds (negative ending cash balance) Interest rate Normal rate + 5%, first emergency loan Normal rate + 15%, second Normal rate + 30%, third Normal rate +45%, fourth and after Reduction in credit rating Ensure sufficient funds by using retained earnings, bank loans (short-term), or issuing stocks or bonds (long-term) to avoid emergency loans

Bond Issue 10-year callable secured bonds in multiples of $1 million Bonds outstanding cannot exceed 75% of net fixed assets of previous quarter. Bonds outstanding cannot exceed 50% of equity. Interest rate depends on market rate and the credit rating of the firm. Bonds may be redeemed, but no more than $500,000 face value in any one quarter.

Stock Issue Minimum of $1 million each issue Stock issue price = shares outstanding x latest market price/(shares outstanding + shares to be issued) Higher credit rating, higher issue price. Add 10% to above issue price for credit rating of 1. Subtract 10% from above issue price for credit rating of 3. Enter number of shares to be issued. Shares can be repurchased at 10% higher than market price leaving at least 3 million shares outstanding and only when accumulated earnings are nonnegative. (Do not repurchase stock when short of cash.)

Stocks Sold by Subsidiaries to Parent Not a decision variable Automatic sale of stocks by subsidiaries to parent in case of insufficient funds for operating and investing requirements. Only way to obtain funds for subsidiaries besides accumulated retained earnings at subsidiaries

Dividends Dividends paid by parent to stockholders Dividends paid in any one quarter combined with dividends paid in previous three quarters cannot exceed the total earnings in previous four quarters. No dividends paid when accumulated retained earnings are negative.

Dividends from Subsidiaries to Parent Not a decision variable 20% of net profit must be set aside until accumulated earnings are at least 50% of capital stock. No dividends paid to parent if cash balance is less than $100,000 in Merica and 1 million pesos in Sereno. No dividends paid to parent if accumulated earnings are negative last quarter.

Certificate of Deposits 3-month CD in multiples of $100,0000 Earn quarterly interest rate on CDs given in the Quarterly Industry Report for 3-month CDs Interest available at the end of each quarter. Principal available in the beginning of next quarter. Short-term investment of funds Do not purchase CDs when short of cash.

Income Statement See page 179 sales - cost of goods sold = gross profit -operating expenses = operating profit + other income - other expenses - income tax =Net profit

Sales and Cost of Goods Sold =Sales to customers + Sales to affiliates + Sales to liquidators Cost of goods sold =beginning inventory + goods manufactured + goods purchased from affiliates (not for consolidated statement) - ending inventory

Goods manufactured Sales forecast for all market areas + safety stock for all market areas -beginning inventory from all market areas

Ending Inventory (in units) For market area with production plant beginning inventory 58,000 +units produced 312,000 - sales to affiliates -207,000 -sales to customers - 103,000 =ending inventory = 60,000

Ending Inventory (in units) For affiliates Affiliate sales office purchases 69,000 + beginning inventory + 21,000 -sales to customers - 75,000 =ending inventory = 15,000 Affiliate sales office purchases Sales forecast 75,000 +safety stock + 15,000 - Beginning inventory - 21,000

Selling Expense Selling expense Advertising expense Sales salaries Sales commissions General selling expense Transportation expense Sales office depreciation

Administrative & General Expense Research and development Training expense Storage expense Executive compensation Other expense

Other Income & Other expenses CD interest Capital gain (loss) Other expense Loan interest Bond interest Income tax

Consolidated Income Statement Zero sales to affiliates Consolidated sales should not include sales to affiliates. Zero purchases from affiliates Consolidated cost of goods sold should not include purchases from affiliates.

Consolidated total sales Do not include sales to affiliates. Home area total sales (including sales to affiliates); $2199=$1009+$1190 Minus home area sales to affiliates; $1190 Plus affiliate sales to customers; $755, $755, $(4841/6)=$806 $2199 - $1190 + $755 + $755 +$806 = $3325

Consolidated cost of goods sold Do not include purchases from affiliates. Consolidated beginning inventory;$549 Plus consolidated goods manufactured;$1494 Minus consolidated ending inventory; $523 = consolidated cost of goods sold;($549+$1494- $523=$1520) Cost of goods sold = Beginning inventory + goods manufactured + purchases from affiliates –ending inventory

Production Cost See page 142 For model 1, 6 lines, 40-hour shift, 312,000 units Labor cost ($2.88x312,000=$899,000)(see report E) Material cost ($1.23x312,000=$384,000) Maintenance cost ($.25x312,000=$78,000) Layoff cost

Production cost continued Equipment depreciation (non cash fixed expenditure) $3,000,000x.035714(1/(7x4))=$107,000 Plant depreciation (non cash fixed expenditure) $0.007937 (1/31.5x4)x$3,300,000=$26,000

Total production cost & unit production cost Labor cost, $899,000 Material cost, $384,000 Maintenance cost, $78,000 Equipment depreciation, $107,000 Plant depreciation, $26,000 Total production cost = $1,494,000 Unit production cost =$1,494,000/312,000=$4.78

Unit fixed cost Increased production unit reduces unit fixed cost. Produce 312,000 units Equipment depreciation per unit: $0.343 Plant depreciation per unit: $0.083 Labor cost per unit: $2.88 Produce 328,000 units Equipment depreciation per unit: $0.326 Plant depreciation per unit: $0.079 Labor cost per unit: $2.95 (overtime)

Tax Losses Reduced consolidated taxable income and taxes during the quarter of the loss. Losses carried forward to future quarters, reducing subsidiary’s taxable income and taxes but not the consolidated taxable income and taxes.

Statement of Cash Flow See page 195 Operating cash receipts - Operating cash expenditures = net operating cash flow Investment receipts - Investment expenditures = net investment cash flow Financing receipts - Financing expenditures = net financing cash flow

Statement of cash flow continued Beginning cash balance + net cash flow = ending cash balance If ending cash balance (for both parent and subsidiaries) <0, emergency loan will be generated. Resulting in sales force resignation, reduced customer demand, lower credit rating, and stock price.

Operating receipts Collection from last quarter sales Collection from current quarter sales For Merica 50% collected current quarter, and 50% next quarter; for foreign subsidiary 40% collected current quarter and 60% collected next quarter Net sales to affiliates Sales to liquidators Subsidiary dividends received CD interest

Operating Expenditures Production cost Purchases from affiliates Operating expense Interest paid Income tax paid

Investment Receipts & Expenditures Fixed assets sold CD matured Expenditures Plant investment New equipment Sales office investment Subsidiary stock purchased CD purchased

Financing Receipts & Expenditures Stock sale Bond sale Bank loans Stocks sold to parent Expenditures Stock repurchased Bonds redeemed Bank loans repaid Dividends paid to stockholders Dividends paid to parent

Consolidated Cash Flow Statement Zero net sales to affiliates Zero purchases from affiliates Zero dividends received from subsidiaries (parent) Zero dividends paid to parent (subsidiaries) Zero subsidiary stock purchased (parent) Zero subsidiary stock sold (subsidiaries)

Balance Sheet See page 203 Current assets + Fixed assets = Total assets Current liabilities + Long-term liabilities =Total liabilities Capital stock +Accumulated retained earnings +Accumulated foreign currency adjustment =Total equity Total liabilities + total equity = total assets

Current Assets Cash Time Deposit CDs Accounts receivable Inventory

Fixed Assets Net sales office Net manufacturing plant Net manufacturing equipment Equity in subsidiaries Other investments

Current liabilities & Long-term Liabilities Accounts payable Bank loans Taxes payable Long-term liabilities Bonds outstanding

Equity Capital stock includes stock issued and repurchased Accumulated retained earnings Accumulated foreign currency adjustment

Consolidated Balance Sheet Zero equity in subsidiaries Capital stock is equal to that of the parent. Accumulated retained earnings are equal to that of the parent. Total equity is equal to that of the parent. Page 200 of Player’s Manual Equity in subsidiaries = capital stock of subsidiaries + accumulated retained earnings of subsidiaries

Retained Earnings Retained earnings = Net profit + dividends received from subsidiaries (parent) - dividends paid to parent (subsidiaries) - dividends paid to shareholders (parent)

Foreign currency adjustment Total assets of foreign subsidiary fall in value if exchange rate rises. They rise in value if exchange rate falls. This change in value is reflected in the consolidated foreign currency adjustment entry on income statement.

Accumulated foreign currency adjustment Consolidated total equity = Consolidated total assets – consolidated total liabilities Accumulated foreign currency adjustment= Consolidated total equity – (Consolidated capital stock and accumulated retained earnings) Accumulated retained earnings and capital stock of foreign subsidiary are translated using historical exchange rates when the earnings were earned and stock sold resulting in discrepancy.

Pro Forma Financial Statements Pro Forma Income Statement Chapter 10 Page 179 Pro Forma Cash Flow Page 195 Pro Forma Balance Sheet Page 203

Financial Statements for Two-Year Plan Quarterly income statement, balance sheet and cash flow statement Consolidated quarterly income statements with annual totals. Consolidated year-end balance sheets. Consolidated quarterly cash flow statements with annual totals. Actual financial statements for years 3 and 4 Pro-forma financial statements for years 5 and 6

Pro Forma Financial Analysis Using your pro forma financial statements to derive the six performance criteria. ROA ROE Market share Stock price: use historic P/E ratio and projected earnings (Price/Earnings Per Share)x EPS Unit production cost Total net income

Pro Forma Financial Analysis continued Compare your projected six performance criteria based on the pro forma financial statements with those set under goals and objectives State whether your objectives are expected to be met by your plans.

Mistakes to be avoided Balance sheet is not balanced. Ending cash in cash flow statement does not agree with the cash in balance sheet. Annual balance sheet is derived from adding numbers of quarterly balanced sheet. Beginning inventory, goods produced, ending inventory in income statement are measured in units.

Final Corporate Report Annual income statement for year 5 and year 6 Annual balance sheet for year 5 and year 6 Annual cash flow statements for year 5 and year 6 Compare actual results of Year 6 with the projected results from the two-year plan. Explain any variances between the actual results and projected results that are greater than 25% in either direction.