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(c) 2001 Contemporary Engineering Economics
1www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
Understanding the Financial Statements
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
2 of 52
Chapter 13Understanding Financial Statements Accounting: The
Basis of Decision-Making
Financial Statements: Financial Status for Businesses
Financial Ratios: Using Ratios to Make Business Decisions
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
3 of 52
Chapter Opening Story – WorldCom’s False Reporting
Accounting Rule Says:Operating expenses should be expensed during the yearthey incur. What WorldCom Did:Operating expenses are capitalized by spreading them over 7 years, just like capital expenditure.
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
4 of 52
Result: WorldCom Reports “Profit” instead of “Loss”
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
5 of 52
A. Why Engineers need to understand the financial statements?
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
6 of 52
Accounting – The Language of Business
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
7 of 52
Financial Status for Business
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
8 of 52
B. Understanding the Balance Sheet
1. The basic accounting equation and the definition of capital
2. How to instantly determine liquidity and too much debt
3. How the firm gets equity: only two ways
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
9 of 52
The Basic Accounting Equation
For the Balance Sheet Presentation
For the Financial Analysis
Assets - Liabilities = Owners’ Equity
Assets = Liabilities + Owners’ Equity
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
10 of 52
How Items Are Arranged on the Balance Sheet
AssetsLiabilities
Owners’ Equity
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
11 of 52
Using the Four Quadrants of the Balance Sheet and Why?
ASSETS LIABILITIES
Current Assets
Long-Term Assets
Current Liabilities
Long-Term Liabilities
Equity
=
1. Owner Contributions2. Retained Earnings
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
12 of 52
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
13 of 52
How to Instantly Determine Liquidity and Too Much Debt Liquidity
Too Much Debt?
Current Ratio (2:1)
Debt To Equity Ratio
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
14 of 52
Liquidity – Current Ratio
ASSETS LIABILITIES
Current Assets
Long-Term Assets
Current Liabilities
Long-Term Liabilities
Equity1. Owner Contributions2. Retained Earnings
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
15 of 52
Too Much Debt? – Debt to Equity Ratio
ASSETS LIABILITIES
Current Assets
Long-Term Assets
Current Liabilities
Long-Term Liabilities
Equity1. Owner Contributions2. Retained Earnings
Deb
t
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
16 of 52
How the Firm Gets Equity: Only Two Ways
Owners’ Contributions
Retained Earnings
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
17 of 52
1. How to Use profit check points
2. Why gross margin is the critical measure for engineers?
3. How does inventory production impact profit?
C. Using the Income Statement to Manage a Business
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
18 of 52
Basic Income Statement Equation
Revenue
Expenses
Net Income (Loss)
-
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
19 of 52
Why Gross Margin is the Critical Measure for Engineers?
Sales
Cost of Goods Sold
Gross Margin
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
20 of 52
How Inventory Production Impacts Profit
Calculating the Cost of Goods Sold
Beginning Inventory
+ Additions to Inventory
- Ending Inventory
Cost of Goods Sold
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
21 of 52
How to Use Profit Check Points
ABC Company, Inc.
Statement of Operations (Year Ended December 31, 200x)
Sales $5,000,000 100.0%
Less: Cost of Goods Sold 3,250,000 65.0%
Gross Profit 1,750,000 35.0%
Less: Selling, G&A Expenses 1,000,000 20.0%
Operating Profit 750,000 15.0%
Less: Interest 250,000 5.0%
Net Income Before Taxes (NIBT) 500,000 10.0%
Less: Taxes 175,000 3.5%
Net Income $325,000 6.5%
Bottom line
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
22 of 52
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
23 of 52
Operating Margin versus Net Margin
Net margin
Operatingmargin
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
24 of 52
D. Understanding the Statement of Cash Flows
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
25 of 52
1. The business operating cycle: How a business earns its cash
2. Sources and Uses of Cash
3. The engineer’s focus on the investing section: Capital Budgeting
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
26 of 52
Shareholders
Fixed Assets
Debt holders
Inventory
Government
Customers
CASHFrom cash sales
To pay taxes
From creditsales
To pay labor,materials, and overhead
To pay interestand principal
From sale of debt
To purchase
From sale
To pay dividend, To purchase back shares
From saleof shares
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
27 of 52
The Cash Flow – Business Cycle
Inventory
Production
Cash
Accountsreceivable
Fixed assets
CashSales
CreditSales
Collection ofreceivable
Investment
Depreciation
• Changes in equity• Changes in liabilities
• Pay taxes• Pay interest• Pay dividends
• Labor• Materials• Overhead
(c) 2001 Contemporary Engineering Economics www.izmirekonomi.edu.tr
Asst. Asst. Prof. Dr. Prof. Dr. Mahmut Ali Mahmut Ali GÖKÇE, Izmir University of EconomicsGÖKÇE, Izmir University of Economics
SpringSpring, 2007, 2007
28 of 52