Economics 410 Managerial Economics Thursday September 30, 1999

Announcements No class on Tuesday, October 5 th Exam Scheduled on Thurs, Oct 28 th Class Lunch Wednesday, Oct 6 th

II. Financial Accounting The Search for Value Accounting is the “language of business” Main Concept –Present Value –Of Future Benefits

The Basics Income Statements Balance Sheets

Balance Sheet Date: September 28, 1999 AssetsLiabilities Net Worth Assets = Liabilities + Net Worth

Balance Sheet Start Business With $ 1,000 AssetsLiabilities Net Worth Cash….$ 1,000 $ 1,000

Balance Sheet AssetsLiabilities Net Worth Cash….$ 1,000 $ 1,000 Buy Equipment for $ 500 ! Cash….$ 500 Eqpt….$ 500

Balance Sheet AssetsLiabilities Net Worth $ 1,000 Cash….$ 500 Eqpt….$ 500 Finance the equipment! Owed to bank…$ 400

Balance Sheet AssetsLiabilities Net Worth $ 1,000 Cash….$ 900 Eqpt….$ 500 Finance the equipment! Owed to bank…$ 400

Balance Sheet AssetsLiabilities Net Worth $ 1,000 Cash….$ 900 Eqpt….$ 500 Owed to bank…$ 400 Go Public ! Sell $ 10,000 in stock! + $ 10,000 Cash + $ 10,000

Balance Sheet AssetsLiabilities Net Worth $ 11,000 Cash….$ 10,900 Eqpt….$ 500 Owed to bank…$ 400

And So Forth Main Principle: Double Entry Accounting Everything As of Some Particular Date

Balance Sheet AssetsLiabilities Net Worth $ 11,000 Cash….$ 10,900 Eqpt….$ 500 Owed to bank…$ 400 Suppose a year goes by !

Balance Sheet AssetsLiabilities Net Worth $ 11,000 Cash….$ 10,900 Eqpt….$ 500 Owed to bank…$ 400 Suppose a year goes by ! Less Depr $ 100 Less $ 100

Balance Sheet AssetsLiabilities Net Worth $ 10,900 Cash….$ 10,900 Eqpt….$ 500 Less $ 100 Depr Owed to bank…$ 400 Buy another company for $ 2,000 - $ 2,000 Cash + $ 2,000 ?

Balance Sheet AssetsLiabilities Net Worth $ 10,900 Cash….$ 10,900 Eqpt….$ 500 Less Depr $ 100 Owed to bank…$ 400 Buy another company for $ 2,000 - $ 2,000 Cash + $ 1,000 Eqpt + $ 1,000 Goodwill?

Balance Sheet AssetsLiabilities Net Worth $ 10,900 Cash….$ 8,900 Eqpt….$ 1,500 Less Depr $ 100 Goodwill $ 1,000 Owed to bank…$ 400

Balance Sheet AssetsLiabilities Net Worth $ 10,900 Cash….$ 18,900 Eqpt….$ 1,500 Less Depr $ 100 Goodwill $ 1,000 Owed to bank…$ 400 Let a year go by

Balance Sheet AssetsLiabilities Net Worth $ 10,900 Cash….$ 18,900 Eqpt….$ 1,500 Less $ 300 Depr Goodwill $ 1,000 Less $ 100 Amort Owed to bank…$ 400 Let a year go by $ 200 in Depr and $ 100 in Amortization !

Goodwill and Depreciable Assets Create Expense Items Reduce reported income each period But no effect on cash flow How to minimize these items on the books is a big issue for public companies

The Income Statement for Quarter Ending Sept 30, 1999 Revenues –Less Expenses (Normal Operating Expenses) Gross Operating Profit (Before Taxes) –Less Depreciation and Amortization –Less Interest –Less Taxes Net Income –Adjustment for Extraordinary Items –Gains or Losses on Portfolio Adusted Net Income

Revenues Recognition Timing –Cash Basis –Accrual Basis Tax Versus Non-Tax

Expenses To Capitalize or Not Accruals Insurance business issues Employee Stock Options

Gross Operating Profit Profit Margins (?) Versus the Industry

Getting to Net Income Less S, G & A Less –Depreciation –Amortization Less –Interest Expense Less –Taxes

So Far Revenue –Less Operating Expenses Gross Operating Profit –Less: SG&A,D, A, I, T Net Operating Income (********) –Less Extraordinary Net Income

EBIT Earnings Before Interest and Taxes Add back in interest and taxes

EBITDA Add back in Depreciation Amortization Cash Flow????

Summary Net Income After Adjustments –Add: Interest and Taxes EBIT –Add: Depreciation and Amortization EBITDA (Some call this “cash flow”) –Less Necessary Capital Expenditures FREE CASH FLOW

One More Time ebitda Less: “Necessary” Cap-Ex Cash flow

Back, to the Balance Sheet Last one was as of June 30, 1999 Assets Liabilities Net Worth Retained Earnings

The End