DECISION MAKING BY THE NUMBERS CHAPTER 8: Accounting DECISION MAKING BY THE NUMBERS

Market Information Goal of business: To create wealth Competing for transactions in the market How can you tell how well you are doing? Measure individual transactions Put them all together – How much “stuff” (acquired wealth) do you have Where did it come from? (assets = liabilities + owners equity) How much new wealth are you creating with it? (revenue - expense = profit)

Financial statements: the main output of financial accounting Financial accounting includes three basic financial statements: Balance Sheet assets: value of the stuff the you or the organization controls liabilities: debt claims against the stuff owners’ equity: owners’ claims against the stuff Income Statement revenues ($ coming in) expenses ($ going out) Statement of Cash Flows Companies with more than $10 million in assets and a class of equity securities that is held by more than 500 owners must file annual and other periodic reports, regardless of whether the securities are publicly or privately traded. The 10-K includes information such as company history, organizational structure, executive compensation, equity, subsidiaries, and audited financial statements, among other information.

The Independent Auditor’s Report: A Necessary Stamp of Approval Publicly traded corporations are required to have a CPA firm perform an external audit Rigorous Process Check figures and methods Physical Counts The auditor will issue an unqualified, qualified or adverse opinion Auditors must be independent

Checking Out the Notes to Financial Statements: What’s in the Fine Print? Additional information may be required to explain the numbers, and notes can be very revealing: Can be many pages… Additional information about operations Clarify and supplement numbers Explain accounting methods or changes Detail status of lawsuits Another important section: Management’s Discussion and Analysis

Managerial Accounting vs. Financial Accounting Purpose Primarily intended to provide information to external stakeholders; stockholders, creditors, and government regulators. Information is generally available to the general public. Primarily intended to provide information to internal stakeholders; managers of specific departments or divisions. Information is proprietary and is not available to the general public. Type of Information Presented Focuses almost exclusively on financial information. Provides both financial and nonfinancial information. Nature of Reports Prepares a standard set of financial statements. Prepares customized reports to deal with specific problems or issues. Timing of Reports Presents financial statements on a predetermined schedule – usually quarterly and annual. Creates repots upon request rather than on a predetermined schedule. Adherence to Accounting Standards Governed by a set of generally accepted accounting principles - GAAP Uses procedures developed internally that are not required to follow GAAP Time period Focus Summarizes past performance and its impact on the form’s present condition. Provided reports dealing with past performance, but also involves making projections about the future when dealing with planning issues.

Looking for Trends in Comparative Statements The SEC requires publicly traded companies to provide comparative financial statements 2-3 years of figures side-by-side View changes over a period of time Trace what has happened to key assets and liabilities Comparative analysis is a form of horizontal analysis

Types of Costs Implicit costs– opportunity costs; not monetary but what is given up Out-of-pocket costs – also called explicit costs; actual expenditures. Payments made to suppliers, workers and rent for office space Fixed costs– do not changes with levels of production Variable costs– rise and vary when the firm produces goods and services

Developing the Key Budget Components: One Step at a Time Master Budget – brings together all of the budgets to represent the overall plan Operating Budgets identify sales and production goals. Sales Budget Production Budget Direct Labor Budget Financial Budgets focus on the firm’s financial objectives. Cash Budget Capital Budget

Balance sheet: what we own and how we got it Balance Sheet – summarizes a firm’s financial position at a specific point in time. Liabilities – indicates what the firm owes to non-owners Assets – things of value that the firm owns Owner’s Equity – the claims owners have against their firm’s assets = +

Sample balance sheet

Foundation & Accounting Numbers Balance Sheet Total % Assets 12/31/08 Cash $5,593 26.8% Accounts Receivable $3,353 16.1% Inventory $2,353 11.3% Total Current Assets $11,299 54.2% Plant & Equipment $14,400 69.1% Accumulated Depreciation ($4,848) -23.2% Total Fixed Assets $9,552 45.8% Total Assets $20,852 100.0%

Foundation & Accounting Numbers Liabilities & Owner's Equity Total % Accounts Payable $2,855 13.7% Current Debt $0 0.0% Long Term Debt $5,200 24.9% Total Liabilities $8,055 38.6% Common Stock $2,313 11.1% Retained Earnings $10,485 50.3% Total Equity $12,798 61.4% Total Liability & Owner’s Equity $20,852 100.0%

The income statement: how did we do? Income Statement – summarizes a firm’s operations over a given period of time in terms of profit and loss. Revenue– the increase in the amount of assets the firm earns Expenses – the cash the firm spends or other assets it uses to generate revenue Net Income – the profit or loss the firm earns - =

Sample income statement Your simulation project calls this “contribution margin”. Your simulation project calls this “variable costs”.

Foundation & Accounting Numbers Income Statement Total % Sales $40,800 100.0 Variable Costs Direct Labor $12,138 29.7 Direct Material $20,240 49.6 Inventory Carry $282 0.7 Total Variable Cost $32,660 80.0 Contribution Margin $8,140 20.0

Period Costs % Depreciation $960 2.4 SGA: R&D $0 0.0 $1,000 2.5 $637 Promotions $1,000 2.5 Sales Administration $637 1.6 Total Period Costs $3,597 8.8 Net Margin $4,543 11.1 Other EBIT Short Term Interest Long Term Interest $641 Taxes $1,365 3.3 Profit Sharing $51 0.1 Net Profit $2,485 6.1

Statement of cash flows: show me the money Operations Investing Financing Note the other statements that are relevant for management and audit. Increase and decrease from all three sources Total amount of cash on hand Stakeholders want to know if there is adequate cash to pay workers, creditors, suppliers and IRS

Sample statement of cash flows

Foundation & Accounting Numbers Cash Flows from Operating Activities: 2011 Net Income (Loss) $2,485 Depreciation $960 Extraordinary gains/losses/writeoffs $0 Accounts Payable $855 Inventory ($2,353) Accounts Receivable $3,647 Net cash from operations $5,593 Cash Flows from Investing Activities:   Plant Improvements Cash Flows from Financing Activities: Dividends Paid ($1,000) Sales of Common Stock Purchase of Common Stock Cash from long term debt Retirement of long term debt Change in current debt (net) Net cash from financing activities Net change in cash position $4,593 Closing cash position

Sarbanes-Oxley act of 2002 Commonly referred to as SOX Banned relationships between CPA firms that might create conflict of interest Created Public Company Accounting Oversight Board (PCOAB) Click the link to view the notes in McDonald’s Annual report noting the independence of their auditors. Note that much of the increased demand in accounting careers are an indirect result of the scandals and the creation of new laws.

Balance Sheet Horizontal Analysis – compares information in a firm’s financial statement over a period of 2 years or more. ASSETS 2014 2013 Cash $2,826 5.3% $4,256 11.9% Accounts Receivable $11,688 22.1% $9,068 25.4% Inventory $4,153 7.8% $0 0.0% Total Current Assets  $18,667 35.2% $13,324 37.3%   Plant & Equipment $44,834 84.6% $30,208 84.5% Accumulated Depreciation ($10,536) -19.9% ($7,787) -21.8% Total Fixed Assets  $34,298 64.8% $22,421 62.7% Total Assets  $52,964 100.0% $35,745 LIABILITIES & OWNERS' EQUITY Accounts Payable $5,426 10.2% $4,204 11.8% Current Debt $867 2.4% Long Term Debt $4,333 8.2% 12.1% Total Liabilities  $9,759 18.4% $9,404 26.3% Common Stock $18,105 34.2% $8,978 25.1% Retained Earnings $25,100 47.4% $17,362 48.6% Total Equity $43,205 81.6% $26,340 73.7% Total Liab. & O. Equity $52,964

Income Statement Vertical Analysis – expresses items on the balance sheet and income statement as a percentage of a key value. Able Asable Abe Amable Ale NA 2019 Total Sales $56,852 $56,826 $66,285 $26,942 $0 $206,905 100.0% Variable Costs:   Direct Labor $6,894 $7,401 $9,968 $4,950 $29,213 14.1% Direct Material $19,086 $23,446 $25,368 $10,824 $78,724 38.0% Inventory Carry $162 $320 $482 0.2% Total Variable $26,142 $30,846 $35,336 $16,094 $108,419 52.4% Contribution Margin $30,710 $25,980 $30,949 $10,848 $98,486 47.6% Period Costs: Depreciation $3,467 $2,153 $2,880 $693 $9,193 4.4% SG&A: R&D $622 $541 $588 $410 $1,000 $3,162 1.5%     Promotions $1,740 $2,500 $2,000 $8,740 4.2%     Sales $3,000 $1,500 $10,500 5.1%     Admin $673 $785 $319 $2,449 1.2% Total Period $9,502 $8,867 $9,753 $4,922 $34,044 16.5% Net Margin $21,208 $17,113 $21,196 $5,925 ($1,000) $64,442 31.1% Other $1,301 0.6% EBIT $63,142 30.5% Short Term Interest 0.0% LongTerm Interest $1,258 Taxes $21,659 10.5% Profit Sharing $804 0.4% Net Profit $39,420 19.1%