2. 2
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
4. 4
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 business
Total Assets - Total Liabilities = Equity
5. 5
Current Assets
Current Liabilities
Long-term (fixed) Assets
Long-term Liabilities
Accounting Terms and Concepts
6. 6
Capital Stock
Paid-in-Capital
Retained Earnings (Deficit)
Accounting Terms and Concepts
7. 7
Financial Statements consists of:
Balance Sheet
Income Statement
Statement of Changes in Financial Position
Statement of Shareholder’s Equity
Accounting Terms and Concepts
8. 8
EXAMPLE #1
Four individuals decide to set-up a small company to manufacture a better
mouse trap.
Investor A contributes $35,000 in cash
Investor B contributes $25,000 in cash
Investor C contributes $10,000 in cash and agrees to pay the
company $10,000 more in 1 year plus
interest 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%
9. 9
Cash $170,000.00
Note Receivealbe From Investor C 10,000.00 Current Asset
TOTAL CURRENT ASSTS 180,000.00
Mouse Trap Patent 30,000.00 Long-Term Asset
Total Assets $210,000.00
Current Portion of Bank Loan $20,000.00 Current Liabilies
Total Current Liabilities $20,000.00
Long-Term Note Payable to Bank 80,000.00 Long-Term Liabilities
TOTAL LIABILITIES 100,000.00
Shareholders' Equity:
Common Stock 10,000.00
Paid-In Capital 100,000.00 Equity
Total Equity 110,000.00
Total Liabilities and Shareholders' Equity $210,000.00
BETTER MOUSE TRAP COMPANY
BALANCE SHEET
10. 10
Accrual Basis of Accounting
Cash Basis of Accounting
Capitalization
Depreciation/Amortization
Expense
Accounting Terms and Concepts
11. 11
Income Statements
Revenue/Sales/Other Income
Cost of Sales and other Costs
Income Taxes
Accounting Terms and Concepts
12. 12
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.
13. 13
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
14. 14
Better Mouse Trap Company Annual
Income Statement
Sales (12,000 x $2.25) $27,000
Interest on investor note 1,000
Cost of Sales (12,000 x $1.25) 15,000
Production period costs 1,750
Other miscellaneous costs 500
17.250
Depreciation on Bldg & M&E 2,500
Interest Expense 12,000
Amortization of Patent (10 years) 3, 000
Total costs and expenses 34,750
Loss from operations before tax (6,750)
Income Tax -
Net Income(loss) (6,750)
15. 15
Mouse Trap’s Fixed Asset
Cost of Fixed Assets
Land $ 5,000
Building 25,000
Machinery and Equipment 10,000
40,000
Estimated Life for Depreciable Assets:
Building - 16 2/3 Yrs
Machinery & Equipment - 10 Yrs
Calculation of Depreciation:
Building = 25,000 / 16,667 = $ 1,500
M&E = 10,000/ 10 = 1,000
TOTAL $ 2,500
16. 16
Better Mouse Trap Company
Balance Sheet
Cash $131,083
Note Receivable from Investor plus Interest 11,000
Accounts Receivables 4,500
Inventory 4,167
TOTAL Current Assets 150,750
Fixed Assets (Net) 37,500
Patent (Net) 27,000
TOTAL Assets $215,250
Current Portion of Bank Loan and Interest $ 32,000
TOTAL Current Liabilities 32,000
Long-Term Note Payable to Bank 80,000
TOTAL Liabilities 112,000
Shareholder’s Equity
Common Stock 10,000
Paid-in-Capital 100,000
Retained Deficit (6,750)
TOTAL LIABILITIES AND SHAREHOLDERS EQUITY $215,250
17. 17
A Better Mouse Trap Company Funds
Statement
Working Capital Provided by (Used by) Operations
Income $ (6,750)
Income not requiring cash
Depreciation and Amortization 5,500
Working Capital Used by Operations (1,250)
Purchase of Fixed Assets (40,000)
Decrease in Working Capital (41,250)
Increase/(Decrease) in Current Assets
Cash $(38,917)
Note Receivable 1,000
Accounts Receivable 4,500
Inventory 4,167
$(29,250)
(Increase)/Decrease in Current Liabilities (12,000)
(12,000)
Decrease in Working Capital $(41,250)
18. 18
Methods of Capturing Cost
Actual 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.
19. 19
Methods of Capturing Cost
Moving 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 = $.25
Issue to Product 12.50 = 50 x $.25
Balance 12.50 = 50 x $.25
Purchase 20.00 / 100 = $.20
Average 32.50 / 150 = $.2167
Issue to Product 10.84 = 50 x .2167
Balance 21.66 = 100 x .2167
20. 20
Methods of Capturing Cost
Standard 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.
21. 21
DEBIT CREDIT
ASSETS Increase Decrease
LIABILITIES Decrease Increase
EQUITY Decrease Increase
INCOME Decrease Increase
EXPENSE Increase Decrease
Rules of Thumb
23. 23
What is EBITDA?
(pronounced e-bit-da)
What does
it mean?
EBITDA is a acronym that stands for
Earnings
Before
Interest,
Taxes,
Depreciation and
Amortization
24. 24
What does it really mean?
In other
words . . .
EBITDA =
Revenues minus Expenses
EBITDA is a simple measure of earnings that indicates
the amount of sales the company makes before subtracting
financing costs for capital expenditures, acquisitions
and payments made in company stock, such as stock
incentives, are calculated.
25. 25
Calculating EBITDA
Revenues 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 service
connected 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 recognized
on revenue items
Other Variance
Manufacturing
Costs
Other costs associated with sales that are considered part of standard
costs (warranty, import duty, scrap)
Contribution Margin Standard Margin minus variances and other variance manufacturing
costs
Period Costs Overhead spending (spending not involved in production)
Other Expenses Miscellaneous items such as foreign currency exchange revaluation
costs
EBITDA Contribution Margin minus period costs – other expense
(this period’s contribution of profit)
26. 26
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.
27. 27
Why isn’t it just called net income?
The term EBITDA came into use during the leveraged buyout
mania 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.
28. 28
Why is EBITDA used?
The term EBITDA came into use during the leveraged buyout
mania 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.
29. 29
EBITDA is a meaningless
financial indicator that
seriously distorts and
misrepresents a business’s
earnings. –
Warren Buffett
31. 31
Standard Margin vs Contribution
Margin
This year Next year
Product Price $100.00 $100.00
Standard Cost 48.00 50.00
Standard Margin 52.00 50.00
Variance 2.00 0.00
Other Costs (warranty
scrap, etc) 5.00 5.00
Contribution Margin 45.00 45.00
45% 45%
33. 33
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.
34. 34
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
36. 36
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.
37. 37
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.
39. 39
Increased Sales Examples
When calculating the EBITDA or potential EBITDA impact we will analyze two scenarios:
Increased sales, same contribution margin, same period cost
Example: 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 cost
Example: 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.
40. 40
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 days
Savings = Averaged daily sales x Days of improvement
