Lecture no02 accounting and financial decisions

Understanding the cash flow statement... • Does the company have high operational costs, low capital expenditure, or investment cash outflows.. Objective of the Company Increase the mar

Accounting and Financial

Decisions

Lecture No 2 Chapter 2

A Why do 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

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 do you need in making your decision?

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

margins ?

• Does the company have high and

consistent returns on investment ?

profit from these investments?

can the company repay its debt?

• Does the company have the ability to

• Does the company have enough

earnings to grow?

Objective of the Company

Increase the market value of the company (Market value measured by stock price reflected in the financial market)

Market values of some of well known U.S firms Company Stock Price

(January 15, 2015) Number of Shares Market Value (mil)

Google $343.03B 339.34M $343.03B

GE $23.73 10.04B $238.40B Coca-Cola $42.52 4.38B $187.39B Wal-Mart $87.50 3.22B $279.64B Apple $107.56 5.86B $641.57B

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 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 do engineers need to

understand the financial statements?

Understanding Financial Statements

 Accounting : The Basis of

Accounting: The Language of Business

Financial Status for Business

B Understanding the Balance Sheet

 What is the basic accounting equation?

 How do you define the capital?

 How do you instantly determine liquidity and too much

debt?

 How does the firm get 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

J&M, Inc.

BALANCE SHEET December 31

Current assets:

Cash and cash equivalents

Short-term marketable sec.

$ 6,100 5,000 19,500 39,800 1,500 3,000 74,900

  + $2,400 – 2,000 + 4,200 – 2,100 500 – 500 + 2,500 Long-term Assets:

Plant and equipment

Less accumulated depreciation

Total assets

  154,000 (70,000) 

$161,400

  145,000 (50,000) 

$169,900

  + 9,000 + 2,000  – 8,500 Liabilities and Shareholders’ Equity      

  26,000 15,000 3,500 44,500

  – 16,000 + 1,000 – 1,500 –16,500 Other liabilities

Long-term debt

Total liabilities

  30,000 

$58,000

  32,000 

$76,500

  – 2,000 –18,500 Shareholders’ equity

Preferred stock, 6%, $100 par value

Common stock, $4 par value (10,000 shares)

Additional paid-in capital

$161,400

  10,000 40,000 11,000 32,400 93,400  

$169,900

  0 0 0 + 9,600 + 9,600   – 8,500

Deferred Charges

• They are conceptually the same as the prepaid expenses.

• Deferred charges are normally referring to

prepaid expenses for intangible assets where the benefits will occur over a long-term period.

• Example: Goodwill, patents, copyrights, or

startup costs during the pre-operating period

Using the Four Quadrants of the

EQUITY

=

a) Owners’

How the Firm Gets Equity: Two Ways

• Owners’ Contributions

o By issuing stocks through financial markets

• Retained Earnings

o By retaining operating profits instead of paying

out cash dividends

C Using the Income Statement to

Manage a Business

 How to use profit check points

for engineers

 How does inventory production impact

profit?

Methods of Reporting Income

Basic Income Statement Equation

Revenue Expenses Net Income ( Loss )

-Measurement of Revenue

Amount Cash Receipts Sales Revenue

Cash sales made

this year $400 $400 $400

Credit sales made

last year but cash

received this year

Credit sales made

this year and cash

received this year

$200 $200 $200

Credit sales made

this year but cash

received next year

Why Gross Margin Is a Critical

Measure for Engineers

How Inventory Production Impacts Profit

Calculating the Cost of Goods Sold

Beginning Inventory + Additions to Inventory

- Ending Inventory

(Cost of Revenue = Cost of Goods Sold)

How to Use Profit Check Points

ABC Company, Inc.

Statement of Operations (Year Ended December 31, 20xx)

Less: Selling, General, and

How to Use Profit Check Points

ABC Company, Inc.

Statement of Operations (Year Ended December 31, 20xx)

Less: Selling, General and

The Income Statement for J&M, Inc

J&M, INC.

INCOME STATEMENT AND RETAINED EARNINGS

(For Year Ending December 31, 2015) Total revenue     $300,000

Cost of revenue

Gross profit

  188,000 

112,000 Operating expenses

The Statement of Retained Earnings

Cash Dividends

Preferred stock $600

Total dividends $10,000 Retained earnings

Beginning of year (01/01/2015) $32,400

Relationship Between Balance Sheets

and Income Statement

Balance Sheet (12/31/2015) Income Statement Balance Sheet (12/31/2014)

(01/01/12 - 12/31/12)

Assets Total revenue 300,000 Assets

Current assets 77,400 Cost of revenue 188,000 Current assets 74,900

Fixed assets 84,000 Gross Profit 112,000 Fixed assets 95,000

Total 161,400 Operating Expenses 58,720 Total 169,900

Operating income 33,280

Liabilities & Equities Liabilities & Equities

Interest expenses 5,200 Current liabilities 28,000 Taxable income 28,080 Current liabilities 44,500

Other liabilities 30,000 Income taxes 8,080 Other liabilities 32,000

Total 58,000 Net Income 20,000 Total 76,500

Preferred stock 10,000 Cash dividends 10,000 Preferred stock 10,000

Common stock 40,000 Common stock 40,000

Additional paid-in capital 11,000 Retained earnings 10,000 Additional paid-in capital 11,000

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

Cash Flow Transactions Within Business

To pay labor, Materials and overhead

To pay interest and principal

From sale

of shares

Statement of Changes in Financial Position

Starting financial position

Sources and uses of funds

Sources and uses of funds

Increase in equity Decrease in assets Increase in liabilities

Decrease in equity Increase in assets

Decrease in equity Increase in assets

Sources

Working Capital Requirement

Working Capital Requirement

(J&M, Inc.)

The Cash Flow Statement for J&M, Inc

Period Ending 31-Dec-2015

Cash from Operating Activities

Net Income $ 20,000 Depreication $ 20,000 Changes in working capital $ (16,600)

Cash Flow from Investing Activities

Capital expenditure $ (9,000)

Total Cash Flow from Investing Activities $ (9,000)

Cash Flow from Financing Activities

Cash dividends paid $ (10,000) Reduction of long-term debt $ (2,000)

Total Cash Flow from Financing Activities $ (12,000)

J&M, INC.

CASH FLOW STATEMENT