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 ACCOUNTING and FINANCE for the NONFINANCIAL EXECUTIVE  An Integrated Resource Management Guide for the 21st Century The St. Lucie Press Library of Executive Excellence Series
 ACCOUNTING and FINANCE for the NONFINANCIAL EXECUTIVE
 An Integrated Resource Management Guide for the 21st Century J A E K . S H I M , P h .D . Professor of Business Administration California State University at Long Beach, California St. Lucie Press Boca Raton London New York Washington, D.C. Library of Congress Cataloging-in-Publication Data Shim, Jae K. Accounting and finance for the nonfinancial executive : an integrated resource management guide for the 21st century / Jae K. Shim. p. cm. — (The library for executive excellence) Includes index. ISBN 1-57444-287-2 (alk. paper) 1. Accounting. 2. Corporations—Finance. I. Title. II. Series. HF5635.S552899 2000 657′.024′655—dc21 00-039041 CIP This book contains information obtained from authentic and highly regarded sources. Reprinted material is quoted with permission, and sources are indicated. A wide variety of references are listed. Reasonable efforts have been made to publish reliable data and information, but the author and the publisher cannot assume responsibility for the validity of all materials or for the consequences of their use. Neither this book nor any part may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, microfilming, and recording, or by any information storage or retrieval system, without prior permission in writing from the publisher. The consent of CRC Press LLC does not extend to copying for general distribution, for promotion, for creating new works, or for resale. Specific permission must be obtained in writing from CRC Press LLC for such copying. Direct all inquiries to CRC Press LLC, 2000 N.W. Corporate Blvd., Boca Raton, Florida 33431. Trademark Notice: Product or corporate names may be trademarks or registered trademarks, and are used only for identification and explanation, without intent to infringe. © 2000 by CRC Press LLC No claim to original U.S. Government works International Standard Book Number 1-57444-287-2 Library of Congress Card Number 00-039041 Printed in the United States of America 1 2 3 4 5 6 7 8 9 0 Printed on acid-free paper Preface This book is directed toward the businessperson who must have financial and accounting knowledge but has not had formal training in finance or accounting — perhaps a newly promoted middle manager or a marketing manager of a small company who must know some basic finance concepts. The entrepreneur or sole proprietor also needs this knowledge; he or she may have brilliant product ideas, but not the slightest idea about financing. The goal of the book is to provide a working knowledge of the fundamentals of finance and accounting that can be applied, regardless of the firm size, in the real world. It gives nonfinancial managers the understanding they need to function effectively with their colleagues in finance. We show you the strategies for evaluating investment decisions such as return on investment analysis. You will see what you need to know, what to ask, which tools are important, what to look for, what to do, how to do it, and what to watch out for. You will find the book useful and easy to read. Many practical examples, illustrations, guidelines, measures, rules of thumb, graphs, diagrams, and tables are provided to aid comprehension of the subject matter. You cannot avoid financial information. Profitability statements, rates of return, budgets, variances, asset management, and project analyses, for example, are included in the nonfinancial manager’s job. The financial manager’s prime functions are to plan for, obtain, and use funds to maximize the company’s value. The financial concepts, techniques, and approaches enumerated here can also be used by any nonfinancial manager, irrespective of his or her primary duties. This book is designed for nonfinancial executives in every functional area of responsibility in any type of industry. Whether you are in marketing, manufacturing, personnel, operations research, economics, law, behavioral sciences, computers, personal finance, taxes, or engineering, you must have a basic knowledge of finance. Because your results will be measured in dollars and cents, you must understand the importance of these numbers so as to optimize results in both the short and long terms. Knowledge of the content of this book will enable you to take on additional managerial responsibilities. You will be better equipped to prepare, appraise, evaluate, and approve plans to accomplish departmental objectives. You will be able to back up your recommendations with carefully prepared financial support as well as state your particular measure of performance. By learning how to think in terms of finance and accounting, you can intelligently express your ideas, whether they are based on marketing, production, personnel, or other concepts. You will learn how to appraise where you have been, where you are, and anywhere you are headed. Financial measures show past, current, and future performance. Criteria are presented to examine the performance of your division and product lines, and also formulate realistic profit goals. Nonfinancial managers should have a grasp of financial topics, but need not be able to arrive at the mathematical answer (e.g., discounted rate of return problem). Nonfinancial managers mainly need to know enough to ask their financial colleagues what the discounted rate of return is for a variety of investment decisions. A decision can then be based on their answer. You should have a basic understanding of financial information so as to evaluate the performance of your responsibility center. Are things getting better or worse? What are the possible reasons? Who is responsible? What can you do about it? You need to know whether your business segment has adequate cash flow to meet requirements. Without adequate funds, your chances of growth are restricted. You must know what your costs are in order to establish a suitable selling price. What sales are necessary for you to break even? You may have to decide whether it is financially advantageous to accept an order at below the normal selling price. If you have idle facilities, a lower price may still result in profitability. You need to be able to express your budgetary needs in order to obtain proper funding for your department. You may have to forecast future sales, cash flows, and costs to see if you will be operating effectively in the future. You will spot areas of inefficiency or efficiency by comparing actual performance to standards through variance analysis. What are the reasons that sales targets differ from actual sales? Why are costs much higher than expected? The causes must be searched out so that corrective action may be taken. You can undertake certain strategies to improve return on investment by enhancing profitability or using assets more efficiently. You have to understand that money is associated with a time value. Thus, you would prefer projects that generate higher cash flows in earlier years. You may also want to compute growth rates. You are often faced with a choice of alternative investment opportunities. You may have to decide whether to buy machine A or machine B, whether to introduce a certain product line, or whether to expand. In managing working capital, you have to get the most out of your cash, receivable, and inventory. How do you get cash faster and delay cash payments? Don’t forget that you need liquid funds to meet ongoing expenditures. Should you extend credit to marginal customers? How much inventory should you order at one time? When should you order the inventory? In financing the business, a decision has to be made whether short-term, intermediate-term, or long-term financing is suitable. The financing mix of the company in terms of equity of debt affects the cost of financing and influences the firm’s risk position. What is the best financing source in a given situation? Taxes are important in any business decision; the after-tax effect is what counts. Proper tax planning will make for wise decisions. Are you maximizing your allowable tax deductions? Financial decisions are usually formulated on the basis of information generated by the accounting system of the firm. Proper interpretation of the data requires an understanding of the assumptions and rules underlying such systems, the convention adopted in recording information, and the limitation inherent in the information presented. To facilitate this understanding, an understanding of basic accounting concepts and conventions is helpful. You should be able to make an informed judgment on the financial position and operating performance of the entity. The balance sheet, the income statement, and the statement of cash flows are the primary documents analyzed to determine the company’s financial condition. These financial statements are included in the annual report. What has been the trend in profitability and return on investment? Will the business be able to pay its bills? How are the receivables and the inventory turning over? Various financial statement analysis tools are useful in evaluating the company’s current and future financial conditions. These techniques include horizontal, vertical, and ratio analysis. Keep this book handy for easy reference throughout your career; it will help you answer financial questions in all the areas mentioned here and in any other matter involving money. Jae K. Shim About the Author Jae K. Shim is Professor of Accountancy and Finance at California State University, Long Beach. He received his M.B.A. and Ph.D. degrees from the University of California at Berkeley (Haas School of Business). Dr. Shim is a coauthor of Handbook of Financial Analysis, Forecasting, and Modeling, Encyclopedic Dictionary of Accounting and Finance, Barron’s Accounting Handbook, Financial Accounting, Managerial Accounting, Financial Management, Strategic Business Forecasting, The Vest-Pocket CPA, The Vest-Pocket CFO, and the best selling Vest-Pocket MBA. Dr. Shim has 45 other professional and college books to his credit. Dr. Shim has also published numerous refereed articles in such journals as Financial Management, Advances in Accounting, Corporate Controller, The CPA Journal, CMA Magazine, Management Accounting, Econometrica, Decision Sciences, Management Science, Long Range Planning, OMEGA, Journal of Operational Research Society, Journal of Business Forecasting, and Journal of Systems Management. He was a recipient of the 1982 Credit Research Foundation Outstanding Paper Award for his article on cash budgeting. Table of Contents Part I Thinking Finance Chapter 1 Financial Decision Making and Analysis .........................................3 1.1 The Nonfinancial Manager’s Concern with Finance ...........................3 1.2 What Are the Scope and Role of Finance?..........................................5 1.3 The Importance of Finance ..................................................................5 1.3.1 The What and Why of Finance .............................................5 1.3.2 What Are Financial Managers Supposed to Do?..................6 1.3.3 What Is the Relationship Between Accounting and Finance? .................................................................................6 1.4 Financial and Operating Environment ...............................................10 1.4.1 What Should You Know About Financial Institutions and Markets?...............................................................................10 1.4.2 Financial Assets vs. Real Assets .........................................10 1.4.3 Basic Forms of Business Organizations..............................11 1.4.3.1 Sole Proprietorship ............................................11 1.4.3.2 Partnership .........................................................12 1.4.3.3 Corporation ........................................................12 1.5 Conclusion ..........................................................................................14 Chapter 2 What Can You Do About Your Departmental Costs? ..................15 2.1 Importance of Cost Data ....................................................................15 2.2 Types of Costs ....................................................................................15 2.2.1 Costs by Function................................................................15 2.2.2 Costs by Ease of Traceability..............................................16 2.2.3 Costs by Timing of Charges Against Revenue ...................16 2.2.4 Costs by Behavior................................................................16 2.2.5 Costs by Averaging..............................................................17 2.2.6 Costs by Controllability.......................................................17 2.3 Other Important Cost Concepts Useful for Planning, Control, and Decision Making.................................................................................17 2.4 How Do Your Costs Behave? .............................................................18 2.4.1 Costs by Behavior................................................................18 2.5 Segregating Fixed Cost and Variable Cost.........................................20 2.6 Cost Allocation ...................................................................................20 2.7 Cost Analysis ......................................................................................20 2.8 What You Can Learn from the Japanese............................................21 2.9 Conclusion ..........................................................................................21