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Mgmt 497
Accounting, Finance & Other Interesting Stuff
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Overview
This lecture will cover the most complicated accounting and finance questions from the Player’s Manual
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Basic Strategies
High price, low share, best quality & features
Rolex
Low price, high market share, low unit cost
Timex
Mid-price pointSeiko
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Basic Strategies
Choose your approachRolex, Timex, Seiko
Establish goals in writingMarket shareUnit costNet incomeROAROEStock price
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Performance Measurement
Performance measures (Weighting Factors) should support strategies
Timex—UPC, market shareRolex—probably not UPC, or market shareFinancial leverage—ROE, not ROA
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Basic Financial Statements
Income statementCash flow statementBalance sheet
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Basic Financial Statements
Consolidated financial statements require
Elimination of intracompany sales and purchases (only sales and purchases between combined entities and the outside world matter)Elimination of intracompany payables and receivables
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Basic Financial Statements
Consolidated financial statements require
Elimination of reciprocal investment accountsTranslation of foreign currency into $US (you can’t add apples and oranges)
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Calculation of Consolidated Sales
See page 164 of Players ManualHome Area sales total (Intracompany and outside): $2,199Intracompany sales: $1,190M2 sales to outsiders: $755M3 sales to outsiders: $755N/P/S sales to outsiders: $806 (4841/6)
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Calculation of Consolidated Sales
Consolidated sales total: $3,325($2,199-$1,190) + $755 + $755 + $806
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Calculation of Consolidated Cost of Goods Sold
Beginning inventory total: $549 $271 +$118 + $118 + $42 (250/6)
Cost of goods manufactured: $1,494Intracompany purchases: $1,190
$397 + $397 + $396 (2,380/6)
Ending inventory total: $523 $287 + $86 + $86 + $64 (382/6)
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Calculation of Consolidated Cost of Goods Sold
Total goods available for sale = Beginning inventory + Cost of goods manufactured + intracompany purchasesConsolidated goods available for sale = Beginning inventory + Cost of goods manufactured (does not include intracompany purchases)
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Calculation of Consolidated Cost of Goods Sold
Consolidated cost of goods sold = Consolidated goods available for sale – consolidated ending inventoryConsolidated cost of goods sold: $1,520($549 + $1,494 - $523)
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Cost Structure
TC = VC + FCIncreased volume reduces unit fixed costIncreased volume may increase unit variable costs (e.g., overtime)Adding FC:• Increases operating leverage• Increases operating risk• May reduce variable costs
Example: Fixed training reduces VC
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Production Cost Analysis
Increased production volume reduces unit fixed costs (depreciation)Decreased production volume increases unit fixed costs (depreciation)See page 128 of Players Manual
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Production Cost Analysis
Equipment depreciation for one quarter: $107,000Plant depreciation for one quarter: $26,000Six lines at 40 hours per week will produce 312,000 units per quarter (100 units/hour for 13 weeks per quarter)Six lines at 42 hours per week will produce 328,000 units (rounded)
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Production Cost Analysis
Produce 312,000 unitsEquipment depreciation per unit: $ .343Plant depreciation per unit: $ .083Labor cost per unit: $2.880
Produce 328,000 unitsEquipment depreciation per unit: $ .326Plant depreciation per unit: $ .079Labor cost per unit: $2.950
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Operating Leverage
Production worker training: $68,000 per quarter, indexed for inflation (fixed cost)Reduction in per unit labor (variable) costs (e.g. $.20 per unit)See page 123-124 of Players Manual
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Production Layoffs and Deactivation
Production layoffs and deactivation lowers morale and output for several quartersA layoff or deactivation of second shift that is replaced by a new first shift has no impact on output
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Tax Loss Carryforwards
If you lose money in a quarter, the business unit in question does not pay taxesLosses may be carried forward to offset future income and reduce future taxesNo loss carrybacks are allowedSee page 174
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Tax Loss Carryforwards
If a subsidiary loses money in a quarter, it pays no taxes that quarter, and the loss reduces consolidated taxable income and taxes in the quarter of the loss (assumes parent’s total taxable income is positive)The subsidiary’s loss is carried forward to a future quarter when it makes income, reducing the subsidiary’s taxable income and taxes in that future quarter
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Tax Loss CarryforwardsThe consolidated net income is not reduced in the future quarter, since the loss was deducted from consolidated net income in the prior quarterIn summary, the loss reduces consolidated net income and taxes in the quarter of the loss, leaves consolidated net income and taxes unchanged in the carryforward year, and reduces subsidiary income and taxes in the carryforward year
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Foreign Currency Gain or Loss
N/P/S revenues and expenses in a quarter are translated into $US at the current exchange rate for that quarterThe Home Area uses the Equity Method of Accounting for its investment in subsidiaries, including N/P/SEquity in Subsidiaries on the Balance Sheet will equal the sum of the Capital Stock and Retained Earnings for each subsidiary (see page 187)
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Foreign Currency Gain or Loss
If the exchange rate rises (falls), Equity in Subsidiaries will decrease (increase), creating a loss (gain) in comprehensive incomeSee page 175 and 187 of Players Manual
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Foreign Currency Gain or Loss
N/P/S beginning Capital Stock: 5,762N/P/S beginning Retained Earnings:2,540 (assumed)Beginning Equity in N/P/S: 8,302Beginning exchange rate: 6.0Ending exchange rate: 6.3 (Rate rises)Foreign currency loss: $66 (see page 175)
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Cash Flow Statement
Net Operating Cash FlowsNet Investment Cash Flows (Home Area)Net Financing Cash Flows (Home Area)See page 179
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Cash Flow Statement
A good company has Operating Net Cash Flow ≥ Operating Net IncomeIf Operating Net Cash Flow ≤ Operating Net Income, there is usually a build up in Accounts Receivable and InventoriesA good company has Operating Cash Flow ≥ Investing Cash Outflows, requiring no additional financing
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Cash Flow Statement
Initially, your net operating cash flow may not be sufficient to cover your investments, and some financing may be requiredHopefully, you will have excess operating cash flow at a later date
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Investing Excess Cash
“Investments”CDsRepayment of debtRepurchase of stock
Need for liquidity
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Operating Cash Inflows
All sales are on creditFor Merica: 50% collected current
quarter; 50% next quarterFor N/P/S: 40% collected current quarter; 60% next quarterNet sales to affiliates and purchases from affiliates result in zero cash flow from a consolidated point of view
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Operating Cash Outflows
All operating expenses except depreciation, are paid in cashTaxes are paid the following quarter, creating a taxes payable liabilityTwo thirds of operating and cash production costs are paid in current quarter; one third are paid in the following quarter
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Investing and Financing Cash Flows
Subsidiary Dividends Received and Dividends Paid to Parent result in zero net cash flow from a consolidated point of viewSubsidiary Stock Purchased and Stock Sold to Parent result in zero net cash flow from a consolidated point of view
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Balance Sheet
The income statement and cash flow statements should be prepared first, and the balance sheet will followThe year end balance sheet, is the Q4 balance sheet, not the sum of quarterly balance sheets
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Balance Sheet
The N/P/S asset and liability accounts on the balance sheet are translated using the “current quarter exchange rate” as of the balance sheet dateThe N/P/S Capital Stock account is translated using the historical rate in effect at the time the stock was sold
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Balance Sheet
The N/P/S Accumulated Earnings account is translated using historical exchange rates in effect when the earnings were earnedThe inconsistent use of current and historical exchange rates necessitates the use of an Accumulated Foreign Currency Adjustment (see pages 192 and 197)
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Accumulated Foreign Currency Adjustment
Consolidated Total Assets minus Consolidated Total Liabilities equals Consolidated Total Equity $12,370 ($14,370-2000)Consolidated Capital Stock and Accumulated Earnings equal $12,373 ($9,500 + 2873), requiring an adjustment of -$3 (plug figure)
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Equity in Subsidiaries
The Home Area uses the “Equity Method” to account for its investment in subsidiariesThe formula for Equity in Subsidiaries is: Beginning Equity in Subsidiaries + Net Income of Subsidiaries – Dividends paid by Subsidiaries = Ending Equity in Subsidiaries
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Equity in Subsidiaries
In the consolidation process, the assets and liabilities of M2, M3, and N/P/S are added to the Home Area’s assets and liabilitiesIn the consolidation process, the subsidiaries are treated as wholly owned “departments” of the Home Area, with no common stock outstanding
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Equity in Subsidiaries
The Home Area’s Capital Stock account includes the value of its original investment in the capital stock of the subsidiariesSince the Home Area is using the Equity Method of Accounting, the net income (Accumulated Earnings) of the subsidiaries has been added to Home Area’s net income (Accumulated Earnings)
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Equity in Subsidiaries
Moreover, the Equity in Subsidiaries account includes the original value of the subsidiaries capital stock and the subsidiaries’accumulated earningsTo avoid “double counting” from a consolidated point of view, the Equity in Subsidiaries is eliminated against the capital stock and accumulated earnings accounts of the subsidiaries in the process of consolidation
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Consolidated Retained Earnings
The formula for Consolidated Retained Earnings is: Beginning Consolidated Retained Earnings + Home Area’s Net Income from its own operations + Subsidiaries’ Net Income from their own operations – Dividends paid to outside shareholders (excluding intercompany dividends)
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Consolidated Retained Earnings
Example: See page 191Home Area NI: $147M2 NI: $ 20M3 NI: $ 20N/P/S NI: $ 53 (316/6)Total NI: $240Total Sub NI: $ 93
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Consolidated Retained Earnings
Intercompany dividends:M2: $ 20 (100% payout)M3: $ 20 (100% payout)N/P/S: $ 42 ((316/6)x.8) (80% payout)Total: $ 82Subsidiary Earnings Retained: $ 11“Outside” dividends: $ 209
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Consolidated Retained Earnings
Beginning RE: $ 2,842+ Home Area NI: +147+M2 NI: + 20+M3 NI: + 20+N/P/S NI: + 53 (316/6)- Outside Dividends: -209Ending RE: $ 2,873
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Repurchase of Stock
Stock repurchases are accounted for using the “par value,” not the cost methodEven though the stock has no “par value,” treat the “book value” as if it were the par value
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Repurchase of Stock
Upon repurchase, the repurchase price is subtracted from cashThe book value of the repurchased shares is subtracted from Capital StockThe excess of the repurchase price over book value is subtracted from retained earningsSee page 190
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Capital Structure
Debt vs. Equity FinancingROA• Profit Margin (NI/Sales) x Asset Turnover
(Sales/Assets) = ROA (NI/Assets)
ROE • ROA x Financial Leverage (Assets/Owners
Equity) = ROE (NI/OE)
Financial leverage• Financing assets with debt
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External Financing Sources
Emergency loans Bank loansBondsStock
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Bank Loans
Emergency loansVery expensive• 1st time r + 5%• 2nd time r + 15%• 3rd time r + 30%• After 3 r + 45%
Generally due to poor planningHurts credit rating
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Bank Loans
For 1 QuarterAutomatic repayment of P + IMaximum: 50% of (AR + Inventory), or$2.5 millionClean out 1 in 4 Qtrs
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Bonds
10 year, callableInterest rate determined on day of issueIssued in multiples of $1 million Maximum = Lesser of (50% equity or 75% fixed assets)
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Bonds
Redeemed in multiples of $100,000 Max redemption = $500,000 per Qtr5% call premium
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Stock Issue
Issued in multiples of 100,000 shares Min value of issue = $1 million
Issue price = (shs outstanding x current market price)
(shs outstanding + new shs issued)
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Issuing New Stock
Current market price $ 10.00 $ 10.00 Current shares outstanding 6,000 6,000 New issue 100 1,000
Price of new issue $ 9.84 $ 8.57
Avg price per share after issue $ 9.997 $ 9.796
• Credit rating 1 yields 10% premium• Credit rating 3 requires 10% discount
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Current Stock Price
Conditions in the stock marketConsistent earnings growthConsistent dividend payout
Dividend policy
Riskiness of stockBased on credit rating
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Investor ROI n-8 n
r = Pn – P8 + Dt - 1 t=9
Pn – P8 = increase in stock price since Q8
n
Dt = dividends paid after Q8 t = 9
r = quarterly rate, 4r = annualized rate
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Repurchasing Stock
In multiples of 100,000 sharesMaximum per qtr = 500,000 sharesRepurchase price = market price + 10% Must have positive RE after transaction Must have a minimum of 3 million shares outstanding
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Credit Rating
Based onCash on handEarnings growthDividend paymentsCapital structure
Bankers like consistency!
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Forecasts
4 rolling quartersAnticipate future needsDeal with lead times
SpreadsheetsTemplates available in game folder
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Forecasts
SalesProduction planCapital requirements (Chapter 9)Financial statements (Income, Balance Sheet, Cash flow) (Chapter 10)Cash flow is ultimate reality check!
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Actual Results
Usually differ from projectionsExternal conditionsExecution failuresErrors in projections
Analyze reasonsTake corrective action
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Two Year PlanDue at the start of week 7Start early and develop own templates or use game templatesIncome statement, cash flow statement, balance sheetBalance sheet must balance!Cash flow must agree with balance sheet!Net income – dividends = change in Retained Earnings
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Final Thoughts
Only two keys to successSolid teamwork• Delegation of responsibilities• Efficient use of time
Clear focus on objectives• Drive business toward goals• Consistency
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Congratulations
On your upcoming graduation !!