Accounting and Financial Decisions Lecture No Chapter Contemporary Engineering Economics, 6th edition Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Contents A Why engineers need to understand the financial statements? B Understanding the balance sheet statement C Using the income statement to manage a business D Understanding the cash flow statement Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Apple Computer • You have money to invest in the market • Apple (AAPL) is trading at $130.42 on May 15, 2015 • What kind of information you need in making your decision? Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Whether or Not to Invest • Does the company have a consumer monopoly or strong brand name? • Does the company have high operational costs, low capital expenditure, or investment cash outflows? • Does the company have flat earnings or are they on a consistent upward trend with good margins? Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved • Does the company have high and consistent returns on investment? • Does the company reinvest earnings and profit from these investments? • Does the company have a low debt-toequity ratio? When earnings are low, can the company repay its debt? Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved • Does the company have the ability to adjust prices for inflation? • Does the company have enough earnings to grow? Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved AAPL (Apple) $130.42: May 15, 2015 Market value = $751.2B $77.24: January 17, 2014 $56.25: June 27, 2013 $100.36: September 21, 2012 Market value = $678.85B $60.85: January 19, 2012 Market value = $412.56B • What causes the stock price to go up and down? Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Objective of the Company Increase the market value of the company (Market value measured by stock price reflected in the financial market) Company values Stock Price of Market Market of some of Number well known U.S Value firms Google GE Coca-Cola Wal-Mart Apple (January 15, 2015) Shares (mil) $343.03B 339.34M $343.03B $23.73 10.04B $238.40B $42.52 4.38B $187.39B $87.50 3.22B $279.64B $107.56 5.86B $641.57B Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Factors That Affect the 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 investors expect the company to perform in the future? – Decisions to invest in various projects and the actual performance of these projects Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved A Why engineers need to understand the financial statements? Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Basic Income Statement Equation Revenue - Expenses Net Income (Loss) Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Measurement of Revenue Transaction Amount Cash sales made this year Credit sales made last year but cash received this year Credit sales made this year and cash received this year Credit sales made this year but cash received next year Total This Year Cash Receipts Sales Revenue $400 $400 $400 $100 $100 $200 $200 $200 $300 $300 $600 $900 Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Why Gross Margin Is a Critical Measure for Engineers Sales Contemporary Engineering Economics, th edition Park Gross Margin Copyright © 2016 by Pearson Education, Inc All Rights Reserved How Inventory Production Impacts Profit (Cost of Revenue = Cost of Goods Sold) Calculating the Cost of Goods Sold Beginning Inventory + Additions to Inventory - Ending Inventory Cost of Goods Sold Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved 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, General, and 1,000,000 20.0% Administration Expenses Operating Profit (margin) Less: Interest Net Income Before Taxes (NIBT) Less: Taxes Net Income (margin) 750,000 250,000 500,000 175,000 325,000 Bottom line Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved 15.0% 5.0% 10.0% 3.5% 6.5% 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, General and 1,000,000 20.0% Administration Expenses Operating Profit (margin) Less: Interest Net Income Before Taxes (NIBT) Less: Taxes Net Income (margin) 750,000 250,000 500,000 175,000 $325,000 Bottom line Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved 15.0% 5.0% 10.0% 3.5% 6.5% The Income Statement for J&M, Inc J&M, INC INCOME STATEMENT AND RETAINED EARNINGS (For Year Ending December 31, 2015) Total revenue Cost of revenue Operating expenses 44,720 Selling/admin 20,000 Depreciation Revenue 37.33% Gross margin 11.09% Operating margin 14,000 Lease expense 58,720 Total Interest pmt (58,720) 33,280 (5,200) 28,080 Income before income taxes Contemporary Engineering Economics, th edition Park Provision for income taxes 100.00% 112,000 Gross profit Operating income $300,000 188,000 FY 2015 6.67% Net margin (8,080) Copyright © 2016 by Pearson Education, Inc $20,000 All Rights Reserved The Statement of Retained Earnings Cash Dividends Preferred stock $600 Common stock 9,400 Total dividends $10,000 Retained earnings Beginning of year (01/01/2015) $32,400 Current year 10,000 End of Year $42,400 Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Relationship Between Balance Sheets and Income Statement Balance Sheet (12/31/2015) Assets Current assets Fixed assets Total 77,400 84,000 161,400 Income Statement (01/01/12 - 12/31/12) Total revenue Cost of revenue Gross Profit Operating Expenses Operating income Balance Sheet (12/31/2014) 300,000 188,000 112,000 58,720 33,280 Liabilities & Equities 74,900 95,000 169,900 Liabilities & Equities Current liabilities Other liabilities Total 28,000 30,000 58,000 Preferred stock Common stock Additional paid-in capital Retained earnings Total Assets Current assets Fixed assets Total 10,000 40,000 11,000 42,000 169,300 Interest expenses Taxable income Income taxes Net Income 5,200 28,080 8,080 20,000 Cash dividends 10,000 Retained earnings 10,000 Contemporary Engineering Economics, th edition Park Current liabilities Other liabilities Total 44,500 32,000 76,500 Preferred stock Common stock Additional paid-in capital Retained earnings Total 10,000 40,000 11,000 32,400 160,400 Copyright © 2016 by Pearson Education, Inc All Rights Reserved D Understanding the Cash Flow Statement 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 Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Cash Flow Transactions Within Business Shareholders To pay dividends, To purchase back shares From sale of shares Government To purchase To pay taxes From sale CASH To pay interest and principal From cash sales Customers Fixed assets From credit sales To pay labor, Materials and overhead From sale of debt Debt holders Inventory Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Statement of Changes in Financial Position Sources Ending financial position Increase in equity Decrease in assets Increase in liabilities Balance Sheet Balance Sheet December 31, 2015 Starting financial position Sources and uses of funds December 31, 2014 Decrease in equity Increase in assets Decrease in liabilities Uses Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Working Capital Requirement Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Working Capital Requirement (J&M, Inc.) Net change in working capital = $100 − (−$16,500) = $16,600 Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved The Cash Flow Statement for J&M, Inc J&M, INC CASH FLOW STATEMENT 31-Dec-2015 Period Ending Cash from Operating Activities Net Income Depreication Changes in working capital Total Cash Flow from Operating Activities $ $ $ $ 20,000 20,000 (16,600) 23,400 Cash Flow from Investing Activities Capital expenditure Total Cash Flow from Investing Activities $ $ (9,000) (9,000) Cash Flow from Financing Activities Cash dividends paid Reduction of long-term debt Total Cash Flow from Financing Activities $ $ $ (10,000) (2,000) (12,000) $ 2,400 Change in Cash (Net cash flow) Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved ... understand the financial statements? Contemporary Engineering Economics, th edition Park Copyright © 2016 by Pearson Education, Inc All Rights Reserved Understanding Financial Statements Accounting: ... Why engineers need to understand the financial statements? B Understanding the balance sheet statement C Using the income statement to manage a business D Understanding the cash flow statement... Statements Accounting: The Basis of DecisionMaking Financial Statements: Financial Status for Businesses Financial Ratios: Using Ratios to Make Business Decisions Contemporary Engineering Economics,