Economics 410Managerial Economics

Thursday

September 30, 1999

Announcements

• No class on Tuesday, October 5th

• Exam Scheduled on Thurs, Oct 28th

• Class Lunch Wednesday, Oct 6th

II. Financial Accounting

• The Search for Value

• Accounting is the “language of business”

• Main Concept

– Present Value

– Of Future Benefits

The Basics

• Income Statements

• Balance Sheets

Balance Sheet

Date: September 28, 1999

Assets Liabilities

Net Worth

Assets = Liabilities + Net Worth

Balance Sheet

Start Business With $ 1,000

Assets Liabilities

Net Worth

Cash….$ 1,000

$ 1,000

Balance Sheet

Assets Liabilities

Net Worth

Cash….$ 1,000

$ 1,000

Buy Equipment for $ 500 !

Cash….$ 500

Eqpt….$ 500

Balance Sheet

Assets Liabilities

Net Worth

$ 1,000

Cash….$ 500

Eqpt….$ 500

Finance the equipment!

Owed to bank…$ 400

Balance Sheet

Assets Liabilities

Net Worth

$ 1,000

Cash….$ 900

Eqpt….$ 500

Finance the equipment!

Owed to bank…$ 400

Balance Sheet

Assets Liabilities

Net Worth

$ 1,000

Cash….$ 900

Eqpt….$ 500

Owed to bank…$ 400

Go Public ! Sell $ 10,000 in stock!

+ $ 10,000

Cash + $ 10,000

Balance Sheet

Assets Liabilities

Net Worth

$ 11,000

Cash….$ 10,900

Eqpt….$ 500

Owed to bank…$ 400

And So Forth

• Main Principle: Double Entry Accounting

• Everything As of Some Particular Date

Balance Sheet

Assets Liabilities

Net Worth

$ 11,000

Cash….$ 10,900

Eqpt….$ 500

Owed to bank…$ 400

Suppose a year goes by !

Balance Sheet

Assets Liabilities

Net Worth

$ 11,000

Cash….$ 10,900

Eqpt….$ 500

Owed to bank…$ 400

Suppose a year goes by !

Less Depr $ 100

Less $ 100

Balance Sheet

Assets Liabilities

Net Worth

$ 10,900

Cash….$ 10,900

Eqpt….$ 500

Less $ 100 Depr

Owed to bank…$ 400

Buy another company for $ 2,000

- $ 2,000 Cash

+ $ 2,000 ?

Balance Sheet

Assets Liabilities

Net Worth

$ 10,900

Cash….$ 10,900

Eqpt….$ 500

Less Depr $ 100

Owed to bank…$ 400

Buy another company for $ 2,000

- $ 2,000 Cash

+ $ 1,000 Eqpt

+ $ 1,000 Goodwill?

Balance Sheet

Assets Liabilities

Net Worth

$ 10,900

Cash….$ 8,900

Eqpt….$ 1,500

Less Depr $ 100

Goodwill $ 1,000

Owed to bank…$ 400

Balance Sheet

Assets Liabilities

Net Worth

$ 10,900

Cash….$ 18,900

Eqpt….$ 1,500

Less Depr $ 100

Goodwill $ 1,000

Owed to bank…$ 400

Let a year go by

Balance Sheet

Assets Liabilities

Net Worth

$ 10,900

Cash….$ 18,900

Eqpt….$ 1,500

Less $ 300 Depr

Goodwill $ 1,000

Less $ 100 Amort

Owed to bank…$ 400

Let a year go by

$ 200 in Depr and $ 100 in Amortization !

Goodwill and Depreciable Assets Create Expense Items

• Reduce reported income each period

• But no effect on cash flow

• How to minimize these items on the books is a big issue for public companies

The Income Statementfor Quarter Ending Sept 30, 1999

• Revenues– Less Expenses (Normal Operating Expenses)

• Gross Operating Profit (Before Taxes)– Less Depreciation and Amortization– Less Interest– Less Taxes

• Net Income– Adjustment for Extraordinary Items– Gains or Losses on Portfolio

• Adusted Net Income

Revenues

• Recognition• Timing

– Cash Basis

– Accrual Basis

• Tax Versus Non-Tax

Expenses

• To Capitalize or Not

• Accruals

• Insurance business issues

• Employee Stock Options

Gross Operating Profit

• Profit Margins (?)• Versus the Industry

Getting to Net Income

• Less S, G & A• Less

– Depreciation

– Amortization

• Less– Interest Expense

• Less– Taxes

So Far

• Revenue– Less Operating Expenses

• Gross Operating Profit– Less: SG&A,D, A, I, T

• Net Operating Income (********)– Less Extraordinary

• Net Income

EBIT

Earnings Before Interest and Taxes

Add back in interest and taxes

EBITDA

Add back in

Depreciation

Amortization

Cash Flow????

Summary

• Net Income After Adjustments– Add: Interest and Taxes

• EBIT– Add: Depreciation and Amortization

• EBITDA (Some call this “cash flow”)– Less Necessary Capital Expenditures

• FREE CASH FLOW

One More Time

ebitda

Less: “Necessary” Cap-Ex

Cash flow

Back, to the Balance Sheet

Last one was as of June 30, 1999

Assets Liabilities

Net WorthRetained Earnings

The End