1. ENGM 661 Engineering Economics for Managers Financial Statements

2. Cost Concepts  Life Cycle Costs the sum of all expenditures associated with an item during its entire service life  first cost machine cost, training, installation, tooling, supporting equipment  operating and maintenance costs  disposal cost (scrap vs book vs market)

3. Sunk Costs

4. Opportunity Costs

5. Direct vs Indirect Costs Direct Material Direct Labor Indirect Material/Labor Fixed General/Admin Selling Profit Conversion cost Selling Price Prime costs Factory Overhead Cost of goods manufactured Cost of goods sold

6. Fixed vs Variable  Fixed - do not vary with production general admin., taxes, rent, depreciation  Variable - costs vary in proportion to the quantity of output material, direct labor, material handling

7. Fixed vs Variable  Fixed - do not vary with production general admin., taxes, rent, depreciation  Variable - costs vary in proportion to the quantity of output material, direct labor, material handling TC(x) = FC + VC(x)

8. Fixed vs Variable TC(x) = FC + VC(x) FC TC VC

9. Break Even Profit = R(x) - FC - VC(x) FC TC R

10. Break Even Profit = R(x) - FC - VC(x) FC TC R

11. Break-Even Analysis SiteFixed Cost/YrVariable Cost A=Austin $20,000 $50 S= Sioux Falls60,000 40 D=Denver80,00030 TC = FC + VC * X

12. Break-Even (cont) Break-Even Analysis 0 50,000 100,000 150,000 200,000 250,000 05001,0001,5002,0002,5003,0003,5004,000 Volume Total Cost Austin S. Falls Denver

13. Example  Company produces crude oil from a field where the basis of decision is the number of barrels produced. Two methods for production are:  automated tank battery  manually operated tank battery

14. Example  Automated tank battery  annual depreciation = $3,200  annual maintenance = $5,200  Other fixed & variable costs

15. Automated Tank Battery TC(x) = (982 + 3,200 + 5,200) + 0.01136 X

16. Example  Manual Tank Battery  annual depreciation = $2,000  annual maintenance = $7,500  other costs

17. Manual Tank Battery TC(x) = (2,000 + 7,500 + 358) + 0.00810 X

18. BreakEven TC A (x) = TC M (x)

19. BreakEven 9,382 + 0.01136 x = 9,858 + 0.0081 x

20. BreakEven TC A (x) = TC M (x) 9,382 + 0.01136 x = 9,858 + 0.0081 x 0.0033 x = 476

21. BreakEven TC A (x) = TC M (x) 9,382 + 0.01136 x = 9,858 + 0.0081 x 0.0033 x = 476 x * = 145,000

22. Example

23. Average vs Marginal Cost x xTC xAC )( )(  x xTC xMC    )( )(

24. Example  Cost of running an automobile is TC(x) = $950 + 0.20 x where $950 covers annual depreciation and maintenance and x is the number of miles driven per year

25. Example 20.0 950)( )(  xx xTC xAC 20.0 ).0950()( )(        x x x xTC xMC

26. Example Average vs Marginal Cost (Automobile) 0.0 0.5 1.0 1.5 010,00020,00030,000 Miles per year cost Average Marginal

27. Marginal Returns

28. Example  Small firm sells garden chemicals. x = number of tons sold per year SP(x) = selling price per ton (to sell x tons) = $(800 - 0.8x) TR(x) = total revenue at x tons = $(800 - 0.8x) x TC(x) = total production cost for x tons = $(8,000 + 400x)

29. Example TP(x) = total profit at x tons = TR(x) - TX(x) = (800x - 0.8x 2 ) - (8,000 + 400x) = -0.8x 2 + 400x - 8,000 Compute a.x at which revenue is maximized b.marginal revenue at max revenue c.x at which profit is maximized d.average profit at max profit

30. Example TR(x) = -0.8x 2 + 800x a.max R tonsx x x xx x xTR 500 8006.1 ) 8.0( 0 )( 2       

31. Example TR(x) = -0.8x 2 + 800x b.Marginal Revenue MR(500) = -1.6(500) + 800 = $0

32. Example TP(x) = -0.8x 2 + 400x - 8,000 c.max profit 250 4006.1 )000,84008.( 0 )( 2        x x x xx x xTP

33. Example TP(x) = -0.8x 2 + 400x - 8,000 c.average profit tonAP xx x xx x /168$)250( /000,84008.0 000,84008.0 )( 2    

34. Terms to define!  Bookkeeping accumulate the results of an entities financial activities  Financial Accounting external evaluation of financial statements of an entity  Managerial Accounting use of economic & financial information to plan and control activities of an entity  Cost Accounting determines product, process, or service costs; a subset of managerial accounting

35. Terms  Tax Accounting the preperation of income tax returns as a specialized field within accounting - tax planning  Auditing external review and evaluation of an entitys’s financial records and health internal audits government audits IRS audits

36. Functions of Accounting  Internal Control all measures used by an organization to guard against errors, waste and fraud  Audits of Financial Statements investigation of a company’s financial statements to determine the fairness of these statements  Annual Reports comparative financial statements enable user’s to identify trends in the company’s performance and financial position

37. Principles of Accounting  Principles of accounting dictate that financial statements must show  financial position at end of accounting period  earnings for the accounting period  cash flows during that period  investments by & distribution to owners

38. Transactions Approach  In recording economic activities, accountants focus on completed transactions - those that cause an immediate change in the financial resources or obligations of a company  purchasing raw materials  sales of finished goods  Strength - the reliability of the information that is recorded, based on past events, objectivity

39. Financial Statements  Balance Sheet financial position of a company indicating resources it owns, debts, and the amount of owner’s equity  Income Statement profitability of the business over the preceeding accounting period  Statement of Owner’s Equity explains changes in the amount of owner’s equity in the business  Statement of Cash Flows summarizes cash receipts and cash payments of business over the preceeding accounting period

40. Balance Sheet  Statement of financial position  does not show the current market value of an entity’s assests  Assets economic resources owned by a business and are expected to benefit future operations u cost principle u going concern u objectivity principle u stable dollar assumption Current Assets - convertible to cash within 1 yr.

41. Balance Sheet  Liabilities probable future sacrifices of economic benefits as result of current obligations Current Liabilities - must be paid within 1 yr.  Owner Equity ownership right of proprietors or stockholders Changes in OE by  investment by owner  earnings from profitable operation of business  withdrawals of cash of other assets  losses from business

42. Accounting Equation Owner Equity = Assets - Liabilities

44. Income Statement  Projects profit/loss of an entity over a period of time  Net Sales - gross sales less returns, defects, etc.  Cost-of-Goods sold - cost of raw material & direct labor  Selling, Gen, Admin - operating expenses of an entity which do not directly contribute to product (sales people, managers,...)  Interest Expense - interest paid on long/short term debt.  Net Income/share - net income (after tax) divided by outstanding shares

46. Changes to Owner Equity  Begin Balance - last year’s ending balance  Paid-in Capital - sold 10,000 shares at $19 /share stock par value of $10 / share. common stock = 10,000 x $10 = $100,000 addition paid in =10,000 x ($19-$10) = $ 90,000  Retained Earnings - cumulative net income which has been retained for business  Dividends - distribution of earnings to stockholders

47. Changes to Owner Equity Balance SheetIncome StatementBalance Sheet 8/31/96 Revenues 8/31/97 - Expenses Net Income Statement of OE A =L +OE Begin Balance Paid in capital changes Retained earnings + Net Income - Dividends Ending BalancesA = L + OE

48. Retained (97) = Retained (96) + $18,000 = $93,900

50. Statement of Cash Flows  Identify the sources and use of cash during year  Operating Activities  net income $18,000 from income statement  depreciation expense $16,400 from balance sheet added back in because it is not an actual cash outlay

54. You Can Go Broke Making Money!

55. Financial Statement Analysis  Liquidity Measures  current ratio  quick ratio  working capital  Long Term Credit Risk  debt to assets ratio  debt to equity

56. Financial Statement Analysis  Profitability Measures  return on assets  return on equity  net profit margin  earnings per share  Activity Ratios  accounts receivable turnover  inventory turnover

57. Liquidity  Working Capital 900,55 400,67300,123    sLiabilitieCurrentAssetsCurrentWC

58. Liquidity  Working Capital Q: Is $55,900 sufficient working capital to cover 2-3 months of expenses? 900,55 400,67300,123    sLiabilitieCurrentAssetsCurrentWC

59. Liquidity  Current Ratio(Industry > 2.0) 83.1 400,67 300,123    sLiabilitieCurrent AssetsCurrent CR

60. Liquidity  Quick Ratio (Industry > 1.0) 03.1 400,67 200,54300,123      sLiabilitieCurrent InventoryAssetsCurrent QR

61. Long Term Credit Risk  Debt to Assets (Industry < 33%) 50.0 100,387 200,193    AssetsTotal sLiabilitieTotal DA

62. Long Term Credit Risk  Debt to Assets (Industry < 33%) 50.0 100,387 200,193    AssetsTotal sLiabilitieTotal DA 1996 0.54

63. Long Term Credit Risk  Debt to Equity Ratio (Industry 33-50%) 996.0 900,193 200,193 '    EquitysOwner sLiabilitieTotal DE

64. Long Term Credit Risk  Debt to Equity Ratio (Industry 33-50%) 996.0 900,193 200,193 '    EquitysOwner sLiabilitieTotal DE 1996 1.182

65. Profitability Measures  Return on Assets(Industry 8-10%) 047.0 2 800,383100,387 000,18     AssetsAverageTotal IncomeNet ROA

66. Profitability Measures  Debt to Equity(Industry 12-15%) 097.0 2/)900,175900,193( 000,18     EquityOwnerAverage IncomeNet ROE

67. Profitability Measures  Net Profit Margin(Industry 4-6%) (Industry Specific) 031.0 800,574 000,18    SalesNet IncomeNet NPM

68. Profitability Measures  Earnings per Share(Industry Specific) 18 000,1,18 tan    dingOutsSharesCommon IncomeNet EPS

69. Activity Ratios  Accounts Receivable Turnover (Industry Specific) 46.13 2/)600,38800,46( 800,574 Re     ceivableAccountsAvg SalesNet ART

70. Activity Ratios  Inventory Turnover(Industry > 10) 365.8 2/)200,48200,54( 300,428     InventoryAverage SoldGoodsofCost IT

71. Financial Leverage

72. 18.0 000,100 000,18.0 000,100 000,18   ROE ROA

73. Financial Leverage

74. 28.0 000, 50 000,14.0 000,100 000,14   ROE ROA

75. Financial Leverage 28.0 000, 50 000,14.0 000,100 000,14   ROE ROA Note: ROI = 18,000/100,000