Upon completion of this chapter you should understand: Reasons for economic success and a brief history of the U.S. economic system, legal forms of the organization and their respective sources of capital, the money cycle, contemporary financial techniques including total financial management and the team triangle approach to financial decision making, financial responsibilities as they relate to the constituents of an organization.
Chapter 1 – Unit 1 Introduction to U.S. Financial System IET 35000 Engineering Economics Learning Objectives – Chapter 1 Upon completion of this chapter you should understand: Reasons for economic success and a brief history of the U.S. economic system Legal forms of the organization and their respective sources of capital The Money Cycle Contemporary financial techniques including total financial management and the team triangle approach to financial decision making Financial responsibilities as they relate to the constituents of an organization Learning Objectives – Unit 1 Upon completion of this unit you should understand: Reasons for economic success and a brief history of the U.S. economic system Legal forms of the organization and their respective sources of capital The Money Cycle Contemporary financial techniques including total financial management and the team triangle approach to financial decision making Financial responsibilities as they relate to the constituents of an organization Introduction Essentially no decision in made in an organization without considering the financial implications The success or failure of an organization is directly linked to financial and economic decisions. The high standard of living in the U.S. is due to capitalism which comes from the economic framework established by the founding fathers and constitution To effectively manage the financial aspects of an organization, an understanding of economic concepts, analysis methods, record‐keeping requirements is essential. Introduction Contemporary management includes the empowerment of employees to take an active role in decision‐making, therefore, an understanding of economic decision tools is essential A key concept within financial decision‐making is the value of money Organizations must never be satisfied – application of continuous improvement is essential to survival. This includes continuous improvement of financial and economic management America’s Economic Success Factors: Economic Freedom – freedom to choose Competitive System – multiple producers Political Stability – stable government Natural Resources – mining and agriculture Management Science – innovation of management techniques Education System – public education Legal System – constitution and common‐law based system America’s Economic Success Factors: (continued) Private Property – key component of capitalism Technology and Science – creativity, inventions and innova on → “Yankee Ingenuity” Comprehensive Monetary System – banking, financial markets and government money system Strong Military – protection of property and economic system Melting Pot – heterogeneous population with variety of skills and abilities Brief U.S. Economic History Agricultural and Crafts Manufacturing Period: Dates: Founding of country into 1800’s Basis of economy was agriculture – 90% of population on family farms. Most product produced was for survival. Cash crops included tobacco and cotton Craft‐based manufacturing – one‐person operations. Shop, manufacturing area and living quarters typically in one building. Examples include: blacksmiths, candle makers, silversmiths, tinsmiths, etc. Brief U.S. Economic History Agricultural and Crafts Manufacturing Period: Characteristics: One‐person businesses and family farms Little mechanization – hand or animal powered tools Little or no external financing of business or farm Barter and exchange rather than cash No financial systems or record keeping Owners in direct contact with customers Brief U.S. Economic History Factory System Period: Dates: 1800 – 1940. Typically referred to as the 1st Industrial Revolution Mechanization of manufacturing occurred using water power and the steam engine Manufacturing moved from craft‐based to factories. Factories hired and paid employees causing a migration from the farm to urban areas Immigrants were hired to work in the factories. 10 Brief U.S. Economic History Factory System Period: Characteristics: Formal organizations patterned after the military Outside investment in factories – partners, shareholders and bank loans Labor specialization and higher output Expansion of banking and financial systems Formation of unions and government regulation such as anti‐trust legislation 11 Brief U.S. Economic History Factory System Period: Characteristics (continued): Emergence of the science of management and industrial engineering Emergence of the corporation due to the ability to raise capital through the sale of stock and bonds Separation of owners, managers and workers from the ultimate customer of the product Financial management, record‐keeping, reporting and economic analysis 12 Brief U.S. Economic History Contemporary Era: Dates: 1940 – today. Typically referred to as the 2nd Industrial Revolution and the Information Age Key concepts affecting economics: Rapid information growth and computer processing of information Rise of international competition Organizational culture change as a result of Total Quality Management (TQM) 13 Brief U.S. Economic History Contemporary Era : Characteristics: Knowledge, information and services outsell manufactured products Over 50% of the economy is based on services Computer and information technology substantially changed how organizations operate Globalization and international competition substantially changed how organization operate and where they locate 14 Brief U.S. Economic History Contemporary Era : Characteristics (continued): Extensive financial analysis tools are employed Manufacturing employs programmable automation and computer control of processes. Organizations have reconnected with the customer Total Quality Management, Six Sigma and Lean concepts have been widely adopted by both service and manufacturing organizations 15 Total Quality Management Total Quality Management (TQM) applications for financial management will be covered in chapter 12. Briefly, TQM characteristics include: Senior management as leaders Change in an organization’s culture Organization driven by customer needs and expectations Prevention rather than detection methods employed Organizational philosophy of continuous improvement Employees empowered to make decisions Continuous training used to support empowerment Fact and statistical based decision making 16 End Unit 1 Material Go to Unit 2 Forms of Organization 17 Chapter 1 – Unit 2 Forms of Organizations IET 35000 Engineering Economics Learning Objectives – Unit 2 Upon completion of this unit you should understand: Reasons for economic success and a brief history of the U.S. economic system Legal forms of the organization and their respective sources of capital The Money Cycle Contemporary financial techniques including total financial management and the team triangle approach to financial decision making Financial responsibilities as they relate to the constituents of an organization 19 Organization’s Legal Form Legal form of an organization affects financial management, taxes, profit‐sharing and financial decision‐making Legal form of an organization also has a direct effect on how capital is raised for expansion or investment in new assets Primary legal forms for organizations in the U.S. are: Proprietorship Partnership Corporation Associated with the three primary forms are special forms such as cooperatives, non‐profits, subchapter‐S corporations 20 and limited partnerships Proprietorship Characteristics include: Single owner who has complete control and may make quick decisions. Easy to form but limited to the life of the single owner Capital limited to owner’s resources, profits and ability to borrow funds (loans) Largest number of organizations in U.S. are the proprietor form. There is no limit to potential size Liability of the owner and organization overlap Owner taxed for the profit/loss of the proprietorship 21 Partnership Characteristics include: Two or more owners resulting in diffusion of control. Decisions affect all partners Partnerships formed by a contract between the partners. Life limited to the natural life of the partners Capital based on partner’s resources, profits and ability to borrow funds (loans) Partnerships may be large in size Profits and liabilities shared by all of the partners Partners taxed as individuals for profit/loss of the partnership 22 Corporation Characteristics include: Formed by a charter from the state. May conduct business as an ‘individual’ such as owning property and entering into contracts Corporation is owned by the shareholders who vote to elect directors who in turn appoint the managers Corporations may sell securities including various classes of stock and bonds Potentially unlimited life. Ownership passed between individuals through share of stock 23 Corporation Characteristics include (continued): Liability of owners (shareholders) limited to their investment. Profits generated may be shared with the owners in the form of dividends or retained for future investment Corporations have special tax requirements: Corporations pay tax on their profits at a different tax rate compared to individuals Owners (shareholders) pay individual income tax on only the dividends they receive from the corporation. 24 Sources of Money Sources of funds to start and operate businesses include: Personal funds (proprietorships and partnerships) Profits generated from successful endeavors. Profits can be reinvested in assets or distributed to the organization’s owners (all forms) Loans from external sources. Conditions and terms vary with type of organization and risk. Loans require repayment with interest (all forms) 25 Sources of Money Bonds are issued by corporations and government agencies and represent debt to the issuing group. They are a type of security issued for a fixed term, usually 10 years or more, and represent a loan to the bond issuer (corporation). Bonds are used to raise funds for specific projects or capital investments. Bonds are typically sold in $1000 multiples with the interest rate based on risk and market conditions Interest only is paid to the owner of the bond until the expiration date at which time the face value is repaid Bonds can be traded on the securities market 26 Sources of Money Common stock is issued by corporations and represents ownership, not debt (corporation). Stock typically is issued for initial start‐up funds or to increase the capitalization of an firm Dividends may be paid if the firm is profitable but are not required Firms may repurchased by the firm to reduce the number of outstanding shares Common stock can be traded on the securities market 27 Sources of Money Preferred stock is issued by corporations and represents ownership, not debt (corporation). Preferred stock differs from common stock in that it carries a fixed dividend rate, similar to bonds Preferred stock can be traded on the securities market If a firm ceases operation, assets of the firm including retained earnings are used in the following order: Repay debt including loans and bonds Compensate owners of preferred stock Compensate owners of common stock. 28 End Unit 2 Material Go to Unit 3 The Money Cycle 29 Chapter 1 – Unit 3 The Money Cycle IET 35000 Engineering Economics 10 Learning Objectives – Unit 3 Upon completion of this unit you should understand: Reasons for economic success and a brief history of the U.S. economic system Legal forms of the organization and their respective sources of capital The Money Cycle Contemporary financial techniques including total financial management and the team triangle approach to financial decision making Financial responsibilities as they relate to the constituents of an organization 31 Financial analysis methods including the time value of The Money Cycle The accounting system money is applied to the Financial decision-making tools such as breakeven accumulates historical Decision results are historical data and minimum cost accounting and financial Financial analysis and financial decision‐making can be described monitored and analysis are used to information improvements are made by the Money Cycle. Figure 1‐1 from the text illustrates the evaluate alternatives on a continuous basis continuous money cycle. 32 The Money Cycle Historical Accounting and Financial Information: Record keeping (bookkeeping) – accumulates the financial data for an organization Managerial Accounting – uses collected data for analysis of manufacturing/service costs, inventory and assets. Used internally by management for measuring performance. Not shared with public other than sometimes lenders Financial Accounting – uses collected data for external reporting including annual statements and taxes. 33 11 The Money Cycle Financial Analysis and Time Value of Money: Tools and techniques are applicable to individuals, small firms and large organizations, and to service and manufacturing organizations Tools and techniques include: Interest calculations Breakeven analysis Minimum cost analysis Replacement decisions Tax analysis Related techniques 34 The Money Cycle Financial Tools and Decisions: Decision making includes analysis of projects, investments, equipment purchase or replacement and other allocation of funds by an organization. Decisions are a result of combining data from record‐keeping with economic analysis techniques Decision emphasis is on operating and tactical decisions that are customer driven Decision making in a modern organization is cross‐functional team driven. 35 The Money Cycle Continuous Financial Improvement: Through monitoring and implementing changes to financial decisions, an organization can improve its financial results Requires equipping personnel of the organization with financial knowledge and decision making skills Techniques include: Financial Measurement Quality Economics Continuous Improvement Methods Total Quality Management 36 12 End Unit 3 Material Go to Unit 4 Financial Decision Making 37 Chapter 1 – Unit 4 Financial Decision Making IET 35000 Engineering Economics Learning Objectives – Unit 4 Upon completion of this unit you should understand: Reasons for economic success and a brief history of the U.S. economic system Legal forms of the organization and their respective sources of capital The Money Cycle Contemporary financial techniques including total financial management and the team triangle approach to financial decision making Financial responsibilities as they relate to the constituents of an organization 39 13 Decision Making Reference: Bowman text – page 13 40 Total Financial Management Total Financial Management – team approach: Team includes financially and technically knowledgeable staff and supported by senior management Team makes financial recommendations and decisions based on customer needs and expectations Team uses financial analysis tools make decisions Team may be: Work‐group teams – members from related work areas Cross‐functional team – members from different departments 41 Money and Organizations Organizations must make financial decisions to optimize the benefit to the organization’s constituents. Organization’s constituents may have competing goals necessitating balancing the needs of the constituents Constituents include: Customers Shareholders/owners Employees Suppliers Lenders Community 42 14 Constituents’ Needs Customers – quality services/products and competitive prices Shareholders/owners – return on their investment Employees – equitable salary and benefits; employment stability; opportunity for growth; and safe/pleasant working environment Suppliers and Lenders – payment on time Community – taxes, positive citizenship and environmentally benign. 43 Economic Analysis Steps in economic analysis and decision‐making include: Identify the issue or improvement to be made Select the desired result, outcome, goal or target Collect data Determine alternative solutions using team‐based techniques Analyze data Select and approve the best alternative Predict outcomes; measure, audit and monitor actual outcomes Improve continuously 44 Topics, Tools and Techniques Topics, tools and techniques that are used to analyze, monitor and improve an organization’s financial position include: Financial statement analysis Cost determination Interest calculations Depreciation methods Time value of money Breakeven analysis Minimum cost analysis Alternative analysis methods Alternative selection methods Replacement analysis Tax effect analysis Economics of quality Continuous financial improvement Total Financial Management techniques 45 15 Financial Decisions Typical financial decisions may include: Meeting the customer’s requirements and expectations Increasing profitability Improving products, processes, services and quality Improving productivity and competitiveness Reducing costs Meeting environmental standards Developing new products and services Improving safety and comfort of work areas Increasing shareholder/owner returns Meeting legal or ethical requirements Simplifying work, processes and methods 46 End Chapter 1 Material Student Study Guide Chapter 1 Homework Assignment Problem Set 1 47 16 ... Manufacturing moved from craft‐based to factories. Factories hired and paid employees causing a migration from the farm to urban areas Immigrants were hired to work in the factories. 10 Brief U.S. Economic History Factory System Period:... accounting system money is applied to the Financial decision-making tools such as breakeven accumulates historical Decision results are historical data and minimum cost accounting and financial Financial analysis and financial decision‐making can be described ... Barter and exchange rather than cash No financial systems or record keeping Owners in direct contact with customers Brief U.S. Economic History Factory System Period: Dates: 1800 – 1940. Typically referred to as the 1st