Accounting and Financial Decisions Engineering Economics

Objective of the Company Increase the market value of the company Market value – stock price reflected in the financial market Market values of some of well known U.S. firms Company Stock Price Market Value (mil) 2010 Market Value (mil) 2014 Google $581.13 $141.138 $344,458.8 Apple $102.64 $295,886.3 $560,337.4 Microsoft $46.56 $238,784.5 Wal-Mart $75.60 $200.68B $256,322.8 Exxon Mobile $96.03 $368,711.5 $432,357.3

Factors that Affect Market Value How is the company doing at a particular time? What is happening to other stock prices, that is, how are the competitors doing? How do investors expect the company to perform in the future – Decisions to invest in various projects and the actual performance of these projects

A. Why Engineers need to understand the financial statements?

Understanding Financial Statements Accounting: The Basis of Decision-Making Financial Statements: Financial Status for Businesses Financial Ratios: Using Ratios to Make Business Decisions

Accounting – The Language of Business

Methods of Reporting Income Cash Basis method Income is not counted until cash (or a check) is actually received, and expenses are not counted until they are actually paid. Transactions are counted when the order is made, the item is delivered, or the services occur, regardless of when the money for them (receivables) is actually received or paid Accrual Basis method

Financial Status for Business

B. Understanding the Balance Sheet The basic accounting equation and the definition of capital How to instantly determine liquidity and too much debt How the firm gets equity: only two ways

The Basic Accounting Equation For the Balance Sheet Presentation For the Financial Analysis Assets = Liabilities + Owners’ Equity Assets - Liabilities = Owners’ Equity

The Balance Sheet Statement for RIM, Ltd.

Using the Four Quadrants of the Balance Sheet and Why? ASSETS LIABILITIES Current Liabilities Current Assets = Long-Term Liabilities Long-Term Assets Equity Owner Contributions Retained Earnings

How to Instantly Determine Liquidity and Too Much Debt? Debt To Equity Ratio

Liquidity – Current Ratio ASSETS LIABILITIES Current Liabilities Current Assets Long-Term Liabilities Long-Term Assets Equity Owner Contributions Retained Earnings

Too Much Debt? – Debt to Equity Ratio ASSETS LIABILITIES Current Liabilities Current Assets Debt Long-Term Liabilities Long-Term Assets Equity Equity Owner Contributions Retained Earnings

How the Firm Gets Equity: Only Two Ways Owners’ Contributions By issuing stocks through financial markets Retained Earnings By retaining operating profits instead of paying

C. Using the Income Statement to Manage a Business How to use profit check points Why gross margin is the critical measure for engineers? How does inventory production impact profit?

Basic Income Statement Equation Revenue - Expenses Net Income (Loss)

Why Gross Margin is a Critical Measure for Engineers? Sales Cost of Goods Sold Gross Margin

How Inventory Production Impacts Profit Calculating the Cost of Goods Sold Beginning Inventory + Additions to Inventory Ending Inventory Cost of Goods Sold

Statement of Operations (Year Ended December 31, 20xx) How to Use Profit Check Points ABC Company, Inc. Statement of Operations (Year Ended December 31, 20xx) Sales $5,000,000 100.0% Less: Cost of Goods Sold 3,250,000 65.0% Gross Profit (margin) 1,750,000 35.0% Less: Selling, G&A Expenses 1,000,000 20.0% Operating Profit (margin) 750,000 15.0% Less: Interest 250,000 5.0% Net Income Before Taxes (NIBT) 500,000 10.0% Less: Taxes 175,000 3.5% Net Income (margin) $325,000 6.5% Bottom line

The Income Statement – Research In Motion Ltd. FY 2009 100.00% Revenue 46.07% Gross margin Operating margin 24.60% 17.10% Net margin

Relationship Between Balance Sheets and Income Statement   Balance Sheet (12/31/09) Income Statement Balance Sheet (12/31/10) (01/01/10 - 12/31/10) Assets Net sales 300,000 Current assets 74,300 Cost of Goods Sold 208,000 76,400 Fixed assets 95,000 Gross Profit 92,000 84,000 Total 169,300 O&M Expenses 58,720 160,400 Net Operating profit 33,280 Liabilities & Equities Non-operating Profit 5,200 Current liabilities 44,500 Taxable Income 28,080 28,000 Other liabilities 32,000 Income Taxes 8,424 30,000 76,500 Net Income 19,656 58,000 Preferred stock 10,000 Cash Dividends 10,056 Common stock 40,000 Capital surplus Retained earnings 9,600 32,800 42,400

D. Understanding the Statement of Cash Flows The business operating cycle: How a business earns its cash Sources and Uses of Cash The engineer’s focus on the investing section: Capital Budgeting

Cash Flow Transactions within Business Shareholders Fixed Assets Debt holders Inventory Government Customers CASH From cash sales To pay taxes From credit sales To pay labor, materials, and overhead To pay interest and principal From sale of debt To purchase To pay dividend, To purchase back shares of shares

The Cash Flow – Business Cycle Pay taxes Pay interest Pay dividends Changes in equity Changes in liabilities Cash Collection of receivable Cash Sales Accounts receivable Production Credit Sales Labor Materials Overhead Inventory Depreciation Investment Fixed assets

The Cash Flow Statement – Research In Motion, Ltd. Operating Activities Financing Activities Investing Activities

Sources and Uses of Cash Statement of Changes in Financial Position Financial position Financial position Balance Sheet Feb. 28, 2009 Balance Sheet March 1, 2010 Sources and Uses of Funds Sources Uses Increase in equity Decrease in assets Increase in liabilities Decrease in equity Increase in assets Decrease in liabilities

The Engineer’s focus on the Investing Section: Capital Budgeting Cash from Operations Cash from Investments Cash from Financing Cash from operations (profit) Cash spent on Property, Plant, Equip. Cash received from bonds and stocks

What is Capital Budgeting? Capital: fixed assets used in production Budget: a plan which details projected cash flows during some future period Capital Budgeting: a process of analyzing projects and deciding whether they should be included in the capital budget

Capital Budgeting Framework Investment Decision Dividend Decision Financing Decision

Major Investment Decision Project Balance Sheet Income Statement Retained Earnings Statement Funds Flow Statement