Finance and Accounting for Nonfinancial Managers Second Edition

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1 Finance and Accounting for Nonfinancial Managers Second Edition

3 Finance and Accounting for Nonfinancial Manager Second Edition Eliot H. Sherman

4 2006 American Management Association. All rights reserved. This material may not be reproduced, stored in a retrieval system, or transmitted in whole or in part, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. ISBN-10: ISBN-13: Printed in the United States of America

5 Contents About This Course How to Take This Course 1 Introduction to Finance 1 The Vocabulary of Finance The Elements of Finance Bookkeeping Accounting Planning Cash Management The Basic Financial Statements The Balance Sheet The Income Statement Statement of Cash Flows Statement of Retained Earnings The Structure of Business and the Impact of Financial Statements Proprietorship Partnership Corporation Other Business Structures 2 Introduction to Accounting 21 The Purpose of Accounting The Accounting System Who Uses Accounting Information? Basic Terminology xi xiii American Management Association. All rights reserved. v

6 vi FINANCE AND ACCOUNTING FOR NONFINANCIAL MANAGERS Financial Statements The Chart of Accounts The Accounting Cycle Using Journal Entries to Record Transactions Closing Procedures More Financial Concepts Preparing Financial Statements The Key Financial Statements Trial Balance 3 Financial Analysis: Using Ratios 43 Analysis of Financial Information The Purpose of Business Who Performs Financial Analysis? The Power of Ratios Comparative Analysis Trend Analysis Traditional Ratio Analysis Liquidity Ratios Activity Ratios Profitability Ratios Debt Management Ratios DuPont Analysis A Different Perspective Creating Other Ratios Conflicting Information 4 Managing Operating Performance 67 Making Your Information Useful The Key Financial Statements Ratios That Help Tell the Company s Story Effect Ratios Crossover Indicators and Causal Ratios 5 Managing Short-Term Assets 89 The Management of Cash American Management Association. All rights reserved.

7 CONTENTS vii Reasons for Holding Cash Techniques for Managing Cash The Management of Other Short-Term Assets Managing Marketable Securities Managing Accounts Receivable Managing Inventory Prepaid Expenses Other Current Assets 6 Relating Risk and Return, Valuation, 105 and Time Value of Money Risk Defining Risk Risk Aversion vs. Risk Taking Possibility of Loss The Determination of Interest Rates Types of Risk Characteristics of Different Types of Risks Default Risk Inflation Risk Maturity Risk Liquidity Risk Estimating Interest Rates Interest Rates and the Economy The Role of the Federal Reserve on Interest Rate Determination Capital Asset Pricing Model Relating Risk and Return Extending the Theory Time Value of Money Valuation An Illustrative Example Assessing Investments Valuing an Investment 7 Capital Investment Decision Making 125 Calculating the Cost of Capital The WACC Model Initial Exercise in Estimating Financing Requirements Calculating the Cost of Capital Capital Budgeting American Management Association. All rights reserved.

8 viii FINANCE AND ACCOUNTING FOR NONFINANCIAL MANAGERS Types of Capital Investment Projects Applying Cost of Capital Determining Investment Cost Determining the Cash Flows of a Project Determining the Terminal Cash Flows Evaluating Capital Investment Projects Payback Period Discounted Payback Period Net Present Value Internal Rate of Return (IRR) Modified Internal Rate of Return (MIRR) Time Value of Money Calculations Using Excel 8 Managing Long-Term Assets 149 Considering Asset Classification The Investment in Fixed Assets Depreciation Fixed Asset Accounting Acquisition of Fixed Assets Other Long-Term Assets 9 Managing Liabilities 161 The Liabilities of the Business Short-Term or Current Liabilities Accounts Payable Notes Payable Taxes Payable Accruals Long-Term Debt Access to Credit Choosing a Bank Lending Officer The C s of Credit Character Capacity Capital Cash Flow Collateral Conditions Competition Credibility Competence American Management Association. All rights reserved.

9 CONTENTS ix Communications Covenants Coverage Banking Relationships Defining Debt Bank Structure Dictates Loan Interest Rates The Cost of Bank Funds Operating Expenses Loan Losses Profit Criteria Comparison to Traditional Business Cost Structure Bank Debt Pricing Loan Pricing Example 10 The Equity in the Business 191 Equity and Business Structure Preferred Stock Common Stock Additional Paid-In Capital Retained Earnings Stock Repurchase Plans The Investment Marketplace Accounting for Equity 11 Financial Planning 203 The Essence of Financial Planning Business Planning A Continuous Process Roles of the Key Players of the Financial Planning Process Planning Sequence The Business Planning Process Business Plan Strategic Plan The Operative Plan or Annual Budget Projecting the Financial Future Estimating Financial Requirements Capital Budgets Cash Budgets American Management Association. All rights reserved.

10 x FINANCE AND ACCOUNTING FOR NONFINANCIAL MANAGERS 12 Corporate Governance 221 Defining Corporate Governance The Major Corporate Scandals Enron WorldCom Tyco International Adelphia Communications Parmalat Global Crossing HealthSouth Scandal Summary The Sarbanes-Oxley Act of 2002 A Summary of the Act s Key Provisions Extended Application of Sarbanes-Oxley The Broader Aspects of Corporate Governance EVA and MVA Executive Compensation 13 Relating Departmental Performance to 239 the Big Picture The Inverted Triangle: Finance from Broad to Specific The Company Subsidiary Division Department Group Individuals The Relationship Between Budgets and Actuals Appendix: Time Value of Money Tables 249 Glossary 255 The Final Exam 265 Index 275 American Management Association. All rights reserved.

Finance and Accounting for. Nonfinancial Managers

Finance and Accounting for. Nonfinancial Managers Finance and Accounting for Nonfinancial Managers Finance and Accounting for Nonfinancial Managers Eliot H. Sherman AMERICAN MANAGEMENT ASSOCIATION Contents About This Course How to Take This Course xi