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Fraser Ch06 2

Yale Universitymath 420
Uploaded: A year ago
Contributor: mayacollin
Category: Botany
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Filename:   Fraser_Ch06 2.pptx (693.06 kB)
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Engineering Economics: Financial Decision Making for Engineers Seventh Edition Chapter 6 Financial Accounting and Business Plans Copyright © 2022 Canada Inc. Learning Goals 6.1 Understand the construction and use of financial statements. 6.2 Understand the role, construction, and use of a business plan. Introduction (1 of 2) Engineers often have broad managerial responsibilities. Should know elements of Financial Accounting & Business Plans. Elements of Financial Accounting: Recording and organizing of financial data. Flows over time (i.e. revenues and expenses). Levels (”snap-shot” of resources, claims on those resources). These statements are used to understand the financial health of the company. Introduction (2 of 2) Business Plans: In a business startup, there is a need to communicate future plans: Company structure, product, human resource capabilities, competitive advantage in order to raise money. Needed when investment is required. Needed to make sound economic and strategic decisions. 6.1 Elements of Financial Accounting (1 of 26) How well is a business doing? Financial Accounting is concerned with recording and organizing the financial data of a business. Includes revenue and expenses, its resources & claims on those resources (for Managers, investors, creditors). 6.1 Elements of Financial Accounting (2 of 26) Management Accounting is concerned with costs and benefits of activities of an enterprise. Provides information to managers for decision-making. Engineers often play a part in Cost Accounting: determining costs of products, processes and services. Introduction to cost estimation is in Appendix 6a. 6.1 Elements of Financial Accounting (3 of 26) The flow of money in a company is much like the flow of water in a network of pipes: Through variables: These variables are measured with respect to time (e.g., income statement). Across variables: These variables are measured at a point in time (e.g., balance sheet). Measuring the Performance of a Firm 6.1 Elements of Financial Accounting (4 of 26) The Balance Sheet: is a snapshot of a firm’s financial position at a particular point in time. It summarizes assets, liabilities and owner equity. The Income Statement: summarizes revenues and expenses over a period of time. (Revenues, expenses, profits before taxes, taxes paid and profits after taxes). Measuring the Performance of a Firm 6.1 Elements of Financial Accounting (5 of 26) Every organization has assets and liabilities (Table 6.1). Assets – Liabilities = Owners’ Equity (company value) Balance Sheet is a snapshot of its financial position. It summarizes, assets, liabilities and owners’ equity. Assets: items to which the organization has legal title. Current assets can be converted into cash within one year. Fixed assets (capital assets) have a life greater than one year. The Balance Sheet 6.1 Elements of Financial Accounting (6 of 26) Liabilities: debt owed (suppliers, employees, government). Current Liabilities – debt normally paid within a year (accounts payable, taxes, wages payable, bank loan payable…). Long-term liabilities – debt normally paid beyond current year. The Balance Sheet 6.1 Elements of Financial Accounting (7 of 26) Table 6.1 Balance Sheet for the Major Electric Company Major Electric Company Balance Sheet as of November 30, 2016 {2D5ABB26-0587-4C30-8999-92F81FD0307C}Assets blank blank Current Assets blank blank Cash blank $ 39 000 Accounts receivable blank 27 000 Raw materials inventory blank 52 000 Finished goods inventory blank 683 000 Total Current Assets blank $ 801 000 Long-Term Assets blank blank Equipment $6 500 000 blank Less accumulated depreciation 4 000 000 2 500 000 Buildings 1 750 000 blank Less accumulated depreciation 150 000 1 600 000 Land blank 500 000 Total Long-Term Assets blank $ 4 600 000 Total Assets blank $5 401 000 6.1 Elements of Financial Accounting (8 of 26) Table 6.1 Balance Sheet for the Major Electric Company (cont.) {2D5ABB26-0587-4C30-8999-92F81FD0307C}Liabilities and Owners’ Equity blank Current Liabilities blank Accounts payable $ 15 000 Loan due December 31, 2016 75 000 Total Current Liabilities 90 000 Long-Term Liabilities Loan due December 31, 2018 1 000 000 Total Liabilities $1 090 000 Owners’ Equity blank Common stock: 1 000 000 shares blank at $3 par value per share $ 3 000 000 Retained earnings 1 311 000 Total Owners’ Equity $4 311 000 Total Liabilities and Owners’ Equity $5 401 000 6.1 Elements of Financial Accounting Owners’ Equity: The difference between assets and liabilities is a means of measuring what the organization is worth – it’s equity: Assets – Liabilities = Owners’ Equity Owners’ equity often appears as two components in a balance sheet: Stock, or shares (at par value: issue price) Retained earnings (cumulative sum of earnings from normal operations and other gains and losses) As equity builds up, the better off are the owners (e.g., a sole proprietor, partnership or shareholders). The Balance Sheet Example 6.2 (1 of 2) Ian Claymore is the accountant at Major Electric. He has realized he forgot to include in the balance sheet of Nov.30, 2020 a govt. loan of $10,000 to help in the purchase of a $25,000 test stand (which he also forgot to include). The loan is to be repaid in two years. When he revises the statement, what changes should he make? Example 6.2 (2 of 2) Govt. loan is long-term liability because due in more than one year, therefore add $10,000 to long-term liabilities. $25,000 test stand will need to be added to equipment so it will increase by $25,000. Cash should decrease by $15,000. The net effect is that assets will increase by $10,000. Balance is maintained as both long-term liabilities and assets have increased by $10,000 6.1 Elements of Financial Accounting (11 of 26) Close-Up 6.1 Three basic ways to structure a business. Sole proprietorship Partnership Corporation 6.1 Elements of Financial Accounting (12 of 26) Close-Up 6.1 Cont. Sole proprietorship Business owned by one person. Simplest and least regulated form of business. Owner keeps all the profits, but at the same time has unlimited liability. 6.1 Elements of Financial Accounting (13 of 26) Close-Up 6.1 Cont. Partnership Business owned by two or more people. All profits and losses are shared according to the partnership agreement. In a limited partnership, some partners are only involved as investors. Limited partners have limited liability Personal assets are protected from creditors. 6.1 Elements of Financial Accounting (14 of 26) Close-Up 6.1 Cont. Corporation Owned by shareholders. Board of directors responsible for selecting managers to run the business. It is a business entity with its own rights and responsibilities, separate from the owners. Owners have limited liability up to the amount of their investment. 6.1 Elements of Financial Accounting (15 of 26) Income Statement summarizes revenues and expenses over a specified accounting period. Major components: Revenue Expenses Profits The Income Statement 6.1 Elements of Financial Accounting (16 of 26) Revenues increase owners’ equity. usually from sales of goods/services. Expenses decrease owners’ equity. cost of goods sold, rent, insurance, wages, depreciation. Income before Taxes is Revenue – Expenses After deducting taxes, we arrive at Net Income. The Income Statement 6.1 Elements of Financial Accounting (17 of 26) Close-Up 6.2 Earnings before interest and taxes (EBIT) Total revenue minus operating expenses Operating expenses: all expenses except for income tax and interest. EBIT measures a company’s operating profit Results from making sales and controlling operating expenses. Used to determine if there is enough profit to recoup the cost of capital. Table 6.2 Income Statement for the Major Electric Company Major Electric Company Income Statement for the Year Ended November 30, 2016 {2D5ABB26-0587-4C30-8999-92F81FD0307C}Revenues blank blank Sales $7 536 000 blank Management fees earned 106 000 blank Total Revenues blank $7 642 000 blank blank blank Expenses blank blank Cost of goods sold $6 007 000 blank Selling costs 285 000 blank Administrative expenses 757 000 blank Interest paid 86 000 blank Total Expenses blank $7 135 000 blank blank blank Income before taxes blank $507 000 Taxes (at 40%) blank 202 800 Net Income blank $ 304 200 Example 6.4 In Example 6.2, Ian Claymore forgot to include the effects of the loan and test-stand purchase in the income statement shown in Table 6.2. When he revises the statement, what changes should he make? Answer: None! Neither the loan nor the purchase of the asset appears directly in the income statement. The loan itself is neither income or expense. If interest is paid on it the interest is an expense. The test stand is a depreciable asset which means that depreciation would appear as an expense, under costs of goods sold. 6.1 Elements of Financial Accounting (18 of 26) Financial statements are often estimates use cost principle of accounting Assets are valued on the basis of their cost (book value), as opposed to market or other values. Land is listed at the price paid, not its market value. Plant and equipment is listed at the price paid less accumulated depreciation. Depreciation on equipment computed using depreciation model. Estimated Values in Financial Statements 6.1 Elements of Financial Accounting (19 of 26) Stock or Shares are listed at par value (issue price). Finished goods inventory – manufacturing cost. Value in the balance sheet reflects what the accountant believes to be a conservative estimate based on experience. Estimated Values in Financial Statements 6.1 Elements of Financial Accounting (20 of 26) Decision makers (inside and outside) need to know general “health” of a firm. Can use balance sheet and income statements to assess “health” of a firm. Financial Ratio Analysis ? key performance indicators These performance measures are financial ratios calculated from items on the income statement and balance sheet. Financial Ratio Analysis 6.1 Elements of Financial Accounting (21 of 26) In interpreting ratios, analysts should: Calculate the ratios over a number of periods to do a trend analysis. Ratios should also be compared to industry standards. Industry standards routinely published by commercial and government websites/publications (Statistics Canada). Financial Ratio Analysis 6.1 Elements of Financial Accounting (22 of 26) See Tables 6.3 and 6.4 (in ch. 6) for past industry-total balance sheet and income statement for the electronic products manufacturing industry. Statistics allow for the comparison of a firm’s financial statements with those of the appropriate industry. Financial Ratio Analysis 6.1 Elements of Financial Accounting (23 of 26) Liquidity ratios assess firm’s ability to meet short term financial obligations & weather unforeseen fluctuations in cash flows. Reserve of cash and liquid assets called working capital. Working capital = current assets ? current liabilities Financial Ratios 6.1 Elements of Financial Accounting (24 of 26) Current ratio = Current assets ÷ Current liabilities A current ratio of 2 is considered adequate. Acid test ratio = Quick assets ÷ Current liabilities Quick assets - those quickly convertible to cash (highly liquid assets) An acid test ratio of 1 is considered adequate. Quick assets include cash and equivalents, marketable securities (stocks, treasury bills, GIC’s, etc.) and accounts receivables. Liquidity Ratios 6.1 Elements of Financial Accounting (25 of 26) Debt management ratios – the extent firm relies on debt. Equity ratio = Total equity ÷ (Total liabilities + Total equity) = Total equity ÷ Total assets Higher the ratio, the less dependent a firm is on debt and the lower the risk of not being able to manage debt. A ratio of 0.4 means the firm has paid for roughly 60% of its assets with debt Comparison to industry norms/trend analysis necessary. Financial Ratios 6.1 Elements of Financial Accounting (26 of 26) Efficiency ratios assess efficiency of use of its assets. Inventory turnover ratio = Sales / Inventories Measures # of times inventories turn over per year Profitability ratios – productive assets have been employed in producing a profit. Return on assets = Net income ÷ Total assets Return on equity = Net income ÷ Total equity Financial Ratios Table 6.8 A Summary of Financial Ratios and Definitions {2D5ABB26-0587-4C30-8999-92F81FD0307C}Ratio Definition Comments Current ratio (Working capital ratio) Current assets/Current liabilities A liquidity ratio Acid-test ratio (Quick ratio) Quick assets/Current liabilities A liquidity ratio (Quick assets = Current assets ? Inventories ? Prepaid items) Equity ratio Total equity/Total assets A leverage or debt-management ratio Inventory-turnover ratio Sales/Inventories An asset management or efficiency ratio Return-on-assets ratio (Net-profit ratio) Net income/Total assets A profitability ratio (excludes extraordinary items) Return-on-equity ratio Net income/Total equity A profitability ratio (measure of investment performance; excludes extraordinary items) 6.2 Preparing a Business Plan (1 of 9) What is a Business Plan? It is a three to five year road map of a business. It outlines operating, marketing, financial and HR status/intentions Identifies nature, feasibility of business, considers financing options and forecasts cash flows For the Owners’ understanding of their business operation Understand cash flows for hiring or investing in assets. Identifies nature and feasibility of the business. 6.2 Preparing a Business Plan (2 of 9) To present firm’s intentions and future revenue to attract investors. One of essential first steps in starting a business Firms with a track record will use balance sheet, income statement, ratios, etc. to disclose financial status. Typical business plan is fairly standardized. 6.2 Preparing a Business Plan (3 of 9) The executive summary is one of the most important parts of a Business Plan. Provides overall picture. Convinces investor to read further! It primarily convinces reader of future company success. Most important features: Company’s mission statement: main goals Products and services that the company provides: key features explained and how they compare to others Overall financial health of company Future plans Executive Summary 6.2 Preparing a Business Plan (4 of 9) High level overview of company and operations Products/services and market needs What indicates there is a need for the product? Who is the customer? Company’s HR capabilities Experience and education of key employees Their alignment with corporate goals Competitive advantages of the company Technology, location, production capability, personnel are compared with other companies with similar products. Company Description 6.2 Preparing a Business Plan (5 of 9) Description of industry and growth plans of company Market demand: discussion of target market: demographics, geographical location, consumers’ interests. Future trends: customer demand, technology and market share projected into future. Strategies to address demand fluctuations. Description of periodic reviews, etc. Market Analysis/Future Outlook 6.2 Preparing a Business Plan (6 of 9) Description of industry and growth plans of company Market share: present / future share compared to competitors. Weaknesses and strengths IT and technology advances Geographical location Financial situation Experience and human factors Pricing, revenue and cash flow predictions Regulatory environment Market Analysis / Future Outlook 6.2 Preparing a Business Plan (7 of 9) Explanation of structure of business in detail Sole proprietorship, partnership or corporation (Close-Up 6.1). Key corporate employee information provided Experience, education, qualifications Functional groups, corporate structure, job titles and duties of employees. How this structure suits corporate mission and future growth. Management and Organization 6.2 Preparing a Business Plan (8 of 9) Discussion of potential sources of funding. Owners and investors Banks and other financial institutions How company will attract investors for new projects or expansion. Funding Requirements 6.2 Preparing a Business Plan (9 of 9) Strategies to penetrate target markets. Creation / maintaining of customers Recognition and fulfillment of customer needs. Communication mechanisms (surveys, advertisements, etc.). Promotions to maintain customer awareness and allow customer to understand the needs of the customer. Sales and Marketing Summary (1 of 2) Elements of financial accounting was discussed. Balance sheet Income statement Use of ratios to assess the financial health of a firm Use caution when interpreting financial ratios. Summary (2 of 2) Preparing A Business Plan Executive Summary Company Description Market Analysis/Future Outlook Management and Organization Funding Requirements Sales and Marketing

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