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 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 Corporations with publicly held stock must publish annual reports with all three statements

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 Assets = Liabilities + Owner’s Equity

Stuff & claims against stuff Car $4,000 Claims against stuff Dave (owner) $3,000 Becky (loan) $1,000

Stuff & claims against stuff House $140,000 Claims against stuff Bank (debt) $115,000 Dave (owner) $ 25,000

Stuff & claims against stuff Car $4,000 Claims against stuff Dave (owner) $3,000 Becky (debt: 6 mo) $1,000 Stuff House $140,000 Claims against stuff Bank (debt) $115,000 Dave (owner) $ 25,000

Snap shot: The Balance Sheet Assets (stuff) car 4,000 house 140,000 total 144,000 Liabilities and Owners Equity short term liabilities (becky) 1,000 long term liabilities (bank) 115,000 equity (car and house) 28,000 $ $

SAMPLE BALANCE SHEET

Foundation & Accounting Numbers Balance Sheet Assets Cash Accounts Receivable Inventory Total Current Assets Plant & Equipment Accumulated Depreciation Total Fixed Assets Total Assets 12/31/07 26.8% 16.1% 11.3% 54.2% 69.1% -23.2% 45.8% 100.0% $5,593 $3,353 $2,353 $11,299 $14,400 ($4,848) $9,552 $20,852

Foundation & Accounting Numbers Liabilities & owner's equity Accounts Payable Current Debt Long Term Debt Total Liabilities Common Stock Retained Earnings Total Equity Total Liability & Owner’s Equity $2,855 $0 $5,200 $8,055 $2,313 $10,485 $12,798 $20,852 13.7% 0.0% 24.9% 38.6% 11.1% 50.3% 61.4% 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. Expenses – the cash the firm spends or other assets it uses to generate revenue Revenue– the increase in the amount of assets the firm earns Net Income – the profit or loss the firm earns Revenue – Expenses = Net Income

SAMPLE INCOME STATEMENT

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 Cash flowing into and out of the firm Operations Investing Financing 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 Note the other statements that are relevant for management and audit.

SAMPLE STATEMENT OF CASH FLOWS

ADDITIONAL FINANCIAL STATEMENTS Statement of Retained Earnings – reports how retained earnings have changed. Stockholder’s Equity Statement – reports how net income and dividends affect retained earnings.

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.

BEYOND THE STATEMENTS Horizontal Analysis – compares information in a firm’s financial statement over a period of 2 years or more. Vertical Analysis – expresses items on the balance sheet and income statement as a percentage of a key value. Ratio Analysis – compares selected items by computing percentages, rates or proportions.

MANAGERIAL ACCOUNTING VS. FINANCIAL ACCOUNTING

MANAGERIAL ACCOUNTING: INSIDE INTELLIGENCE Reports and analysis for informed business decisions Product Costing Accurate measure and analysis of costs Activity Based Costing (ABC)

INCREMENTAL ANALYSIS Evaluates the financial impact of different alternatives in a decision-making situation. Make parts or buy from supplier? Repair equipment or buy new? Perform repairs or outsource? Eliminate or sell product line/business?

INCREMENTAL ANALYSIS DECISION An electronics firm produces high definition LCD televisions at a rate of 10,000 per month. It currently makes its own speaker sets for the televisions. A supplier offers to sell the firm similar speakers at a cost of $23 per television. The firm could lower costs by buying the speakers, $23 is less than $26. Right?

COST OF MAKING TELEVISION SPEAKERS: MAKE OR BUY?