Download - SBS - Lean Accounting Principles

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Page 1: SBS - Lean Accounting Principles

Finance for Non-Financial Managers

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Module Objects

By the end of this module you should be able to: Describe key financial terms Identify elements of a balance sheet/income statement Explanation of EBITDA Identify sources of savings

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UNDERSTANDING OF KEY FINANCIAL TERMS

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Accounting Terms and Concepts

Assets - Items that a person or business owns Liabilities - Sums of money owed by a person or

business Equity - The net worth of a person or businessTotal Assets - Total Liabilities = Equity

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Current Assets Current Liabilities Long-term (fixed) Assets Long-term Liabilities

Accounting Terms and Concepts

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Capital Stock Paid-in-Capital Retained Earnings (Deficit)

Accounting Terms and Concepts

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Financial Statements consists of: Balance Sheet Income Statement Statement of Changes in Financial Position Statement of Shareholder’s Equity

Accounting Terms and Concepts

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EXAMPLE #1

Four individuals decide to set-up a small company to manufacture a better mouse trap.

Investor A contributes $35,000 in cashInvestor B contributes $25,000 in cashInvestor C contributes $10,000 in cash and agrees to pay

the company $10,000 more in 1 year

plusinterest at 10%.

Investor D contributes His patent on the mouse trap which he and the others agree is worth

$30,000.The investors decide to make each share have a par value of $10.00 and

to issue 1,000 shares divided by each owner’s respective interest. The company also borrows $100,000 from the local bank payable $20,000 per year with interest at 12%

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Cash $170,000.00Note Receivealbe From Investor C 10,000.00 Current AssetTOTAL CURRENT ASSTS 180,000.00

Mouse Trap Patent 30,000.00 Long-Term AssetTotal Assets $210,000.00

Current Portion of Bank Loan $20,000.00 Current LiabiliesTotal Current Liabilities $20,000.00

Long-Term Note Payable to Bank 80,000.00 Long-Term LiabilitiesTOTAL LIABILITIES 100,000.00

Shareholders' Equity:Common Stock 10,000.00Paid-In Capital 100,000.00 EquityTotal Equity 110,000.00

Total Liabilities and Shareholders' Equity $210,000.00

BETTER MOUSE TRAP COMPANY BALANCE SHEET

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Accrual Basis of Accounting Cash Basis of Accounting Capitalization Depreciation/Amortization Expense

Accounting Terms and Concepts

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Income Statements Revenue/Sales/Other Income Cost of Sales and other Costs Income Taxes

Accounting Terms and Concepts

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BETTER MOUSE TRAP CO.

The company bought machinery and equipment, a small building and land for $40,000.00

They manufactured 15,000 mouse traps and sold 12,000 of which 10,000 are paid for and 2,000 are still to be paid. Each mouse trap cost $1.25 to manufacture and was sold for $2.25.

The company spent the following: manufacturing wages $15,000 utilities 1,500 operating supplies 250 materials 4,167 other miscellaneous 500

10% of the materials purchased were still on hand at the end of the year.

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BETTER MOUSE TRAP CO.

In order to develop the cost of what was sold and the value of what remains on hand and without becoming terribly complicated we need to decide which costs will make-up the direct cost of our product because they vary with the value of the product and which will be attributed to the passage of time. For this example, we decided on: Material and wages as the direct costs Utilities and supplies as period costs Other miscellaneous as other cost of operations.

As a result of this decision, inventory would be costed as follows Labor per mouse trap = 15,000 / 15,000 traps = $1.00 each Material per mouse trap = (4,167-417)/15,000 traps = $.25 each Totaling $1.25

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Better Mouse Trap Company Annual Income Statement

Sales (12,000 x $2.25) $27,000Interest on investor note 1,000Cost of Sales (12,000 x $1.25) 15,000Production period costs 1,750Other miscellaneous costs 500

17.250Depreciation on Bldg & M&E 2,500Interest Expense 12,000Amortization of Patent (10 years) 3, 000

Total costs and expenses 34,750Loss from operations before tax (6,750)

Income Tax -Net Income(loss) (6,750)

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Mouse Trap’s Fixed Asset

Cost of Fixed AssetsLand $ 5,000Building 25,000Machinery and Equipment 10,000

40,000Estimated Life for Depreciable Assets:

Building - 16 2/3 YrsMachinery & Equipment - 10 Yrs

Calculation of Depreciation:Building = 25,000 / 16,667 = $ 1,500M&E = 10,000/ 10 = 1,000

TOTAL $ 2,500

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Better Mouse Trap Company Balance Sheet

Cash $131,083Note Receivable from Investor plus Interest 11,000Accounts Receivables 4,500Inventory 4,167TOTAL Current Assets 150,750Fixed Assets (Net) 37,500Patent (Net) 27,000

TOTAL Assets $215,250Current Portion of Bank Loan and Interest $ 32,000TOTAL Current Liabilities 32,000Long-Term Note Payable to Bank 80,000

TOTAL Liabilities 112,000

Shareholder’s EquityCommon Stock 10,000Paid-in-Capital 100,000Retained Deficit (6,750)

TOTAL LIABILITIES AND SHAREHOLDERS EQUITY $215,250

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A Better Mouse Trap Company Funds Statement

Working Capital Provided by (Used by) OperationsIncome $ (6,750)Income not requiring cash

Depreciation and Amortization 5,500Working Capital Used by Operations (1,250)Purchase of Fixed Assets (40,000)

Decrease in Working Capital (41,250)

Increase/(Decrease) in Current AssetsCash $(38,917)Note Receivable 1,000Accounts Receivable 4,500Inventory 4,167

$(29,250)(Increase)/Decrease in Current Liabilities (12,000)

(12,000)Decrease in Working Capital $(41,250)

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Methods of Capturing CostActual Cost

Each element of cost is specifically identified to the item produced.

Example - In producing mouse traps there is a piece of wood, if an employee receiving $10.000 per hours produced 100 pieces of wood per hour, then each one would cost $.10. If however another employee receives $15.00 per hours for the same production, then the cost changes to $.15. If per hour production varies (90, 100, 105) we have a variance in the labor portion of the wood cost.

Actual cost rapidly becomes complicated and difficult to track.

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Methods of Capturing CostMoving Average Cost

Each item is costed based on an average of costs necessary to produce the item.

Example - If I buy wood for my traps on two different dates I would proceed as follows:First Purchase - Cost of wood for 100 traps = $25.00 ($.25/trap)

Purchase $25.00 / 100 = $.25Issue to Product 12.50 = 50 x $.25Balance 12.50 = 50 x $.25Purchase 20.00 / 100 = $.20Average 32.50 / 150 = $.2167Issue to Product 10.84 = 50 x .2167Balance 21.66 = 100 x .2167

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Methods of Capturing CostStandard Cost, Variance

Standard Cost - The actual cost to produce an item is estimated and then fixed for some period of time based on the estimate.

Variance - The difference between the estimated cost and the actual cost.

Example - If during the first month of producing mouse traps we spend

$1,250 to produce 1,000 traps, each cost $1.25 compared to a standard of $1.00. There is then a variance of $.25 per trap or $250.00 in total.

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DEBIT CREDITASSETS Increase DecreaseLIABILITIES Decrease IncreaseEQUITY Decrease IncreaseINCOME Decrease IncreaseEXPENSE Increase Decrease

Rules of Thumb

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EBITDA - WHAT IS IT?

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What is EBITDA?(pronounced e-bit-da)

What doesit mean?

EBITDA is a acronym that stands for Earnings Before Interest, Taxes, Depreciation and Amortization

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What does it really mean?

In otherwords . . .EBITDA =

Revenues minus Expenses

EBITDA is a simple measure of earnings that indicatesthe amount of sales the company makes before subtractingfinancing costs for capital expenditures, acquisitionsand payments made in company stock, such as stockincentives, are calculated.

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Calculating EBITDARevenues Sales value of items shipped to customer or service performed + other

income items (agent commissions, property disposals)Cost of Sale at Standard Margin

Standard costs (updated once each year) of components and serviceconnected to each revenue item.

Standard Margin Revenues minus cost of sales at Standard

Variances from Standard

Costs that fall higher or lower than standard margin costs recognizedon revenue items

Other Variance Manufacturing Costs

Other costs associated with sales that are considered part of standardcosts (warranty, import duty, scrap)

Contribution Margin Standard Margin minus variances and other variance manufacturingcosts

Period Costs Overhead spending (spending not involved in production)

Other Expenses Miscellaneous items such as foreign currency exchange revaluationcosts

EBITDA Contribution Margin minus period costs – other expense(this period’s contribution of profit)

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Why isn’t it just called cash flow?

Cash flow is the cash that company collects each month minus the cash the company sends out each month. Sales are seldom paid for in cash and in some companies, the cash for the invoiced sales are not usually collected for approximately 90-120 days. Therefore, sales and cash flow are not the same thing.

Because EBITDA is not the same as cash flow.. It is a simplified earnings measurement.

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Why isn’t it just called net income?

The term EBITDA came into use during the leveraged buyoutmania of the 1980s. This measurement is useful when you want to see the earnings that could be net income if the company didn’t owe money for investments such as acquisitions or large expenditures like building new plants or purchasing new equipment. EBITDA is a good measure of what net income -- could be -- in the future, when debts are paid off. It also is a helpful measure to use when comparing earnings for divisions of the company.

Because EBITDA is not the same as net income.. It is a simplified earnings measurement.

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Why is EBITDA used?

The term EBITDA came into use during the leveraged buyoutmania of the 1980s. This measurement is useful when you want to see the earnings that could be net income if the company didn’t owe money for investments such as acquisitions or large expenditures like building new plants or purchasing new equipment. It also is a helpful measure to use when comparing earnings among the business units of the company.

EBITDA is a good measure of earnings without the debt from investments.

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EBITDA is a meaningless financial indicator that seriously distorts and

misrepresents a business’s earnings. –

Warren Buffett

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Margins, Inventory Turns, DSOs

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Standard Margin vs Contribution Margin

This year Next year

Product Price $100.00 $100.00Standard Cost 48.00 50.00Standard Margin 52.00 50.00

Variance 2.00 0.00Other Costs (warranty

scrap, etc) 5.00 5.00Contribution Margin 45.00 45.00

45% 45%

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Possible Sources of Savings

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Period Cost Savings

Period cost savings is defined as a reduction of headcount or spending in the period cost area.

Period cost savings can be the result of multiple factors: Reduced cycle time or increased throughput Reduced Expenses Properly assigning human resources qualifications to jobs.

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Contribution Margin

Savings in the contribution margin category are based on the reduction of manufacturing costs.

Standard costs Manufacturing variances

Material (price, usage, substitution, etc) Labor (spending, alternate routing, setup, etc) Subcontract (premiums, etc)

Warranty expense Concessions Scrap Rework

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Materials

Material savings can be accomplished through: Better pricing agreements Substitutions Reduction of scrap

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Labor and Overhead

When a project contemplates a reduction in direct labor hours , three assumptions are available: To reduce direct labor hours (touch time) without a formal decision of

what to do with the new available hours. To increase output making use of the new available capacity. A combination of the two options above.

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Warranty and Concessions

Another source of contribution margin savings: Effectively eliminating the source of the warranty call. Reducing the cost of warranty per warranty call. Lost revenues due to having to respond to warranty calls.

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Revenue Growth

INCREASE SALES!!!!!

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Increased Sales Examples

When calculating the EBITDA or potential EBITDA impact we will analyze two scenarios:

Increased sales, same contribution margin, same period costExample: Original Sales 20 New sales 40 Increment 20

• Cont. Mrg. 10 Cont. Mrg. 20 Increment 10• Period Cost 05 Period Cost 05 Increment 0• EBITDA 05 EBITDA 15 Increment 10

To the 10 units of Incremental EBITDA we will apply the probability determined by S&M and the result will be the EBITDA and potential EBITDA.

Increased sales, same contribution margin, higher period costExample: Original Sales 20 New sales 40 Increment 20

Cont. Mrg 10 Cont. Mrg. 20 Increment 10 Period Cost 05 Period Cost 10 Increment 05 EBITDA 05 EBITDA 10 Increment 05

To the 5 units of incremental EBITDA we will apply the probability determined by S&M and the result will be the EBITDA and potential EBITDA. In this example we take the hit of the period cost in the incremental revenue category to avoid placing negative savings on the period cost category of EBITDA.

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Working Capital

Inventory: Reducing cycle time increases the turns of inventory.

Days Sales Outstanding: Average Daily Sales = Previous quarter sales annualized

(multiplied times 4) divided by 360 daysSavings = Averaged daily sales x Days of improvement