BEC

Forecasting Techniques

* internal and external analysis driven by historical data and actual expectations that can be quantitative or qualitative - Forecasting Analysis: + Revenues: by product of independent variables such as expectations regarding economy/income/competition + Expenses: by product of independent variables such as overall fixed cost andVC

Payback Period Method

* the time required for the net after-tax cash inflows to recover the initial investment in a project - Focuses on both liquidity and risk ==> the greater the risk of an investment the shorter the payback period *** Net initial investment ÷ avg incremental cash flow - Adv: easy to use and understand and emphasizes liquidity - Limitations: time value of money is ignored / cash flows after initial investments are not considered / reinvestment CF not considered / PPI neglected

Cost Behavior (Fixed vs variable)

** cost driver = as volume incr, variable costs increases - Variable: variable costs change in total but remain fixed per unit - Fixed: as volume goes up total cost remains the same but cost per unit decreases ==> rent / output = out per unit - Semi Variable (mixed cost): total mfg OH ==> fixed base but usage part is variable - Relevant Range: a range for which the assumptions of the cost driver are valid ==> total fixed cost will not change **** pg 44 ***

Mitigating and Controlling Economic and Transaction Exposure

- Defined by the degree to which PV of cash flows of the business can be affected by fluctuations in exchange rates - Freely Fluctuating Exchange rates correct a lack of equilibrium in the balance of payments

Capital Budgets

- Evaluate the capital additions of the org ofter over a multiyear period ==> highly dependent on availability of cash or credit

Application of NPV: Leases and Buy Decisions

- Issue: + Finance lease must meet OWNES requirements + Operating lease ==> lease exp - Decision making: Pg 41 graph + Finance: look at the after tax of debt vs WACC for investment decisions **** Pg 42 *** - Effect on F/s: Key ratios ==> debt to equity and interest coverage ratio + borrow to buy/finance ==> DE will increase and interest coverage will decrease + operating ==> DE will decrease and appear less risky thus increase credit rating

Sell or process further

- Joint costs: Costs of a single process that yields multiple products ==> considered sunk cost - separable costs ==> costs incurred after split off point ==> relevant costs *** pg 67

Applying the IC Framework

- Manage Application / Evaluate Effectiveness / Deficiency Assertions ==> reduce risk to acceptable levels + Framework Documents: COPS * Overall assessment * Component Evals * Principal Evals: source for isolating and defining IC deficiencies

Inventory Management Types

- Market Value: Lifo ==> median value of: + Replacement costs: cost to purchase inv on val date + market ceiling ==> net selling price less the costs to complete and sips of inventory + Market floor ==> market ceiling less a normal profit margin + NRV ==> FIFO/WA: net selling price les costs to complete and dispose of - Periodic Vs perpetual inventory systems: + Periodic ==> inventory quantities are determined by physical counts performed at least annually + Perpetual ==> inventory balance is updated for each purchase and each sale + WA ==> COGAFS / # units

Controls: Selecting / Developing / implementing / Responding

- Must consider: 1. Laws, Rules, and Regs 2. Nature of entity's business and markets 3. Scope and nature of operating model 4. Competence of personnel 5. Use and dependence of Technology - Selection and Development of Controls: + Workshops or control activists inventories + Implement controls for outsourced function + Segregation of Duties

Liquidity Ratios

- Working capital = Current assets - Current liabilities - Current Ratio = Current assets / Current liabilities + the higher the ratio the better because it implies ability to meet ST obligations - Quick ratio: (Cash and cash equivalent + ST marketable Sec + net Rec) ÷ Current liabilities + the higher the better b/c shows more liquid assets can pay ST liabilities - Operating CF ratio: CF from ops ÷ ending current Lieb + Higher ratio implies company is generating enough cash to pay liabilities and if declining signals to find alt financing - WC turnover: Sales ÷ avg WC + the higher is better but too high indicated a WC amount that is too low

Flexible Budgeting

Allows for adjustment for changes in production or sales and accurately reflects expected costs for the adjusted output + Assumptions and uses ==> revenue per unit, VC per unit, and FC over the relevant range + Benefits ==> can display different volume levels to pinpoint areas in which efficiencies have been achieved or rate has occurred - Limitations ==> highly dependent on the accurate identifications of fixed and variable cots and determination of relevant range *** 74

Learning curve

As workers become more familiar with a specific task, the per unit labor hours will decline ==> VC per unit should decline until steady period is achieved - Activity itself must be receptive in nature involves intense labor and have little to no labor force turnover - as cumulative production doubles ==> cumulative avg time per unit falls to a fixed % of the previous avg

High-Low Method

Estimates the fixed and variable portions of cost + Compare the high and low volumes and costs + use either the high volume or low volume to calc variable costs by multiplying the volume times the variable cost per unit + then subtract that total VC from total cost to get fixed cost + Flex budget formula: series of budgets for a range of activity levels *** Total costs = FC + { VC per unit * # of units}

Cost volume profit Analysis:

Forecast profits at different levels of sales and production volume ==> breakeven analysis - Assumptions: + Cost can be separated into either VC or FC + Volume is only relevant factor + cost behave in linear fashion to volume + cost behaviors are constant + cost show greater variability over time + uniform contribution margin + product mix remains constant

Residual income

Measures Value added for stockholders in dollars - Measures actual income earned by an investment over return required (WACC) *** RI = Net income - Required return + required return = NBV(equity) * hurdle rate - Benefits of RI Performance measures: ease of measurement of actual dollars earned by an investment above its required amount + Realistic target rates ==> hopefully CAPM a rate that will motivate management to meet + Focus on Target return and amount: advantage over ROA and ROI ==> encourages mgmt to invest in projects that generate income in excess of target or calc rate improving profits + Weaknesses ==> target rate requires judgement (how do we estimate required rate of return on equity) *** pg 57

Economics

Science that studies human behavior as the relationship between ends and scarce means that have it uses ==> affects individuals / companies / government performances

Budget Policies

Series of formal budget polices - Mgmt participation - Budget guidelines: + Changes to the environment + org goals + results year to date + tone for budget + Corp policies

SOX act of 2002 Title XI

Title IX ( Corp Fraud Accountability): - Tampering with records: 20 year prison term - Temporary freeze authority for SEC: escrow pmts - SEC can prohibit certain people from servicing as officer or director if that individual has violated securities rules and regs

SOX act of 2002 Title IX

Title IX (White Collar crime Penalty Enhancements): penalties for mail and wire fraud is 20 years and ERISA violation increased to 100,00 and 10 years - Sentencing Guidelines: will review and amend as needed to carryout the provisions of the Attempt and conspiracy act as well as review any additional aggravating or mitigating circumstances for a particular offense that could justify an exception to the existing sentencing ranges - Failure of Corp officers to certify reports: periodic reports must contain + written stmt that report complies with SEC + Written stmt that info is fair + Signed by CEO and CFO + If you certify knowing reports don't comply: fined up to 1,000,000 and imprisoned 10years + If willfully certify: 5,000,000 and 20 years

SOX act of 2002 Title VII

Title VII ( Corp and Criminal Fraud Accountability): *** individuals who alter, destroy, mutilate, conceal, cover up, falsify, or make false entry in any record, document, or tangible object with intent to impede or obstrcuct an investigation can be fined and imprisoned for not more 20 years *** Auditors should retain documents for 7 years and failure to do so can result in fines and 10 year imprisonment - Statue of limitations: earlier of two years after discovery or 5 years after the violation - Whistle-Blower Protection: an employee who provides evidence of fraud may not be discharged, demoted, suspended, threatened, harassed, or in any other matter discriminated against - Comp damages: Reinstatement / back pay with interest / compensation for special damages - Criminal Penalties for Securities fraud: 25 years and fined

Marginal Analysis

focuses on the relevant revenues and costs that are associated with a decision - Relevant revenues and costs: relevant only if the change as a result of selecting different alternatives + Can be fixed or variable + specifically traceable to cost object that may change as a result of selecting different alts. ==> Direct costs ==> prime costs ==> discretionary costs ==> incremental costs: marginal costs, differential costs, or out of pocket costs ==> opportunity costs + irrelevant costs + Sunk costs + Controllable costs ==> can be relevant or irrelevant + Uncontrollable costs ==> irrelevant + Avoidable costs and Revenues ==> relevant costs + Unavoidable costs ==> irrelevant

Leverage and Risk

* As leverage goes up risk goes up but expected return goes up - Operating leverage: fixed cost independent of sales ==> rent, depreciation, insurance + if you are capital intensive ==> high OL + Labor intensive ==> low OL + Sales must be high enough to cover fixed OC + measured as % ∆ EBIT ÷ % ∆ Sales - Financial Leverage: use of debt rather than equity ==> interest exp independent of sales + % ∆ EBT or EPS ÷ % ∆ EBIT + the higher the fin leverage the higher the risk of bankruptcy - Value of a levered Firm= (value of an unlettered firm + PV of the interest tax savings ) *** PV of interest tax saving = T * (R * D) / R

Discounted Payback Period

* Considers time value of money PV = FV / ( 1+r)^n PV = PMT * (( 1-(1/(1+r)^n) ÷ r )

Valuing Tangible Assets

- Cost method ==> NBV = P - Deprec - Market value ==> replacement cost or NRV - Appraisal value - Liquidation value ==> price if you were to sell it today

Asset Structure:

- Current Assets: the more current assets you have the more liquid you are and less risk of distress but less ROA - Noncurrent: greater risk of success due to low liquidity but higher ROA - If you have more debt you must be more liquid to meet demands

Target Costing

establishing product cost allowed to ensure both profitability per unit and total sales volume - Cost determination: as competition sets prices, any change in price could easily cause customer defection + Target cost = market price - Required profit - implication of target costing: Serious measure must be employed to reduce costs ==> sacrifice quality / incr downstream costs to differentiate their product and create brand royalty / advanced cost mgmt tech may have to be employed

Projection Techniques

* Multiple hypothetical "What-if" scenarios and course of actions ==> internal use - Sensitivity Analysis: experimenting with different parameters and assumptions + risk mgmt tool ==> which variables are the most sensitive to change - Scenario analysis: multiple different scenarios which represent alt. possible outcomes ==> probabilities may be assigned

IRR

* Single discount rate ==> expected rate of return on project - Accept if IRR > Hurdle rate - Focuses decisions on % - Limitations: does not tell you the dollar value added and assumes an unreasonable reinvestment assumption ==> assumes to reinvest at IRR - Misleading when you have alt periods of cash inflows and outflows and doesn't tell you profit or loss like NPV does

Supply Chain mgmt / Integrated Supply Chain mgmt

* When a firm and entire supply chain are able to reasonably predict the expected demand of consumers for a product and then plan accordingly to meet that demand - If actual demand of customer is met and excess supply does not exist in market ==> firm can minimize costs - SCOR: Plan / Source / Make / Deliver + Plan ==> properly balance demand and supply 1. determine demand 2. assess ability of suppliers 3. Plan inventory levels 4. Plan distrib. of Inventory 5. Plan purchase of RM + Source: procure the resources required to meet it 1. selecting vendors + Make: turn the RM into FG that are produced to meet demand 1. Production process 2. Manufacturing 3. Testing 4. Packaging + Delivering: Activities of getting the finished product into the hands of consumers to meet demand (A/R) 1. managing orders 2. Forecasting 3. Pricing 4. managing AR and collections - Benefits of implementing Supply chain mgmt: cost down and profits up ==> happy customers and vendors

Financial and Non-financial performance measures

* accomplishing goals ==> balanced scorecard - Financial measures: Profit ==> cost of quality, ROI, ROA, residual income - Non-financial Measures: ICA + External benchmarks: productivity measures ==> efficiency / variance (ratio of the outputs achieved to the inputs of production ) ==> the higher the better *TFP: output/total cost * Partial productivity ratio = output / specific qty of material or labor + Internal benchmarks: find and analyze problems * control charts: determine "zero" defects ==> statically quality control that determines if its within acceptable range * Pareto Diagram: histogram that determines quality control issue that are most frequent and often demand greatest attention * Cause and Effect (fishbone): find most frequent defects and problems then use the diagram to identify sources of problems in the process by resource and take corrective action

Cost objects

* resources or activities that serve as a basis for mgmt decisions. a single cost object can have more than one measurement - Product costs: + Not expensed until product is sold + Components: DM + DL + MOH - Period costs: I/S only + Expenses in period incurred and not inventorialable + SGA and interest - Manuf. cost: not expensed until sold + capitalized as an asset and expensed when sold + components ==> DM + DL and indirect (MOH) - Nonmanuf. cost ==> cost that don't relate to manuf of product (SGA and interest) - Income determination - Efficiency:

Working Capital

*** Goal of working capital management is to maximize shareholder wealth *** the more conservative WC policy the more long term assets, permanent current assets, and temp current assets are funded by LT financing - With high working capital a entity has lower risk but could have lower ROA - with lower WC firm is taken on more risk in return for higher ROA - Less WC increases risk by exposing company to less likely to meet current obligations - In terms of risk ==> a decline in current ratio implies reduce ability to generate cash - unless ST liquidity is relevant, the current ratio isn't best measure of health - Quick ratio= (Cash and cash equivalent + short term marketable securities + net receivables) ÷ Current liabilities + ability to meet current obligations without inventory is important - Cash Conversion cycle: want to be less than or equal to industry stds = Days in inventory + Days sales in accounts receivable - days of payable outstanding + Inventory turnover = COGS / Avg inventory + Days in inventory = Ending inventory / (COGS ÷ 365) +Lax Credit policy ==> sell fast but collect slower + Tight credit Policy ==> sell slower but collect faster + AR turnover = Sales ÷ avg AR + Days sales in AR = ending AR / (Sales ÷ 365) *** Avg gross receivable = Avg daily sales * avg collection period *** Take full advantage of interest free grace period but don't be late + AP turnover = COGS / Avg AP + Days in AP = ending AP / (COGS ÷ 365) *** Days in inventory ==> more days in inventory can mean obsolete and sunk cost while short days can mean not enough inventory on hand to support potential sales *** Days in AR ==> fewer days is ideal but may lose sales and too many days means struggling customers *** Days in AP ==> too short presents risk of not utilizing cash enough and too long means relationships between vendor is deteriorating - Working Capital turnover: Efficiency ==> higher the better = Sales / Avg working Capital ( current A - current L)

Impact of Cap structure on Fin Ratios

*** Solvency is determined by its Cap structure *** - Total Debt ratio: the lower the ratio the greater the level of solvency and the greater the presumed ability to pay debts ==> lower return of equity - Debt to Equity: Lower the ratio the lower the risk involved so lower ROE - Times interest earned = EBIT ÷ Interest expense ===> the lower the ratio he higher the risk

Process costing

*** product costing that averages costs and applies them to large number of homogenous items - Production report: costs incurred for a period as well as all units produced during that period are accumulated on a production report that accounts for the physical flow of units *** pg 46 - Equivalent units: Costs must be attached to completed units as well as to the units partially complete at the end of each period + equals the amount of DM/DL or conversion costs necessary to complete one unit of production + process costing assumption: transfers in are 100% complete - CALC of Avg unit costs: cost flow assumptions: cost averaging depend on FIFO and or weighted avg cost flow assumptions - CALC FIFO: Equivalent units: composed of 1. completion of units on hand at the beginning of the period BB *( 1- % already completed) 2. units started and completed during the period (units completed - Beg WIP) 3. units partially complete at the end of the period (EB * % complete) **** Current cost / equivalent costs *** current cost incurred during period are allocated to equivalent units produced during that period **** - Calc using WA: Two components 1. Units completed during the month ( Beg WIP + units started and completed during month) 2. units partially complete at the end of the period (EB * % complete) *** total costs, including both the costs of beginning inventory and current costs, are allocated to equivalent units to arrive at WA unit cost *** Weighted Avg = (Beginning cost + current cost) ÷ equivalent units *** pg 48 *** - Spoilage (shrinkage): + Normal ==> inventory cost (BS) included in standard costs + Abnormal ==> (income statement) excluded from standard cost because it is a period cost

Benefits and Limitations of Absorption and Variable costing

- ABS: + Benefits: GAAP and IRS requirements + Limits: level of inventory affects income so net income is less reliable because the cost of the product include fixed costs - Variable costing: + Benefits: VC and FC are separated and can easily be traced to and controlled / NI is more reliable / isolates CM to aid in decision making + Limits: it is not GAAP or IRS

Valuation using accounting estimates

- AR ==> NRV - INV ==> LCM - Fixed assets ==> Cost - AD = NBV - Contingent lieb ==> best estimate - Historical info must be justified - market info ==> current values in market - Expected usage ==> depreciate per unit - Estimates from experts ==> lawsuits - Review and approved by auditors and supported by documentation

Security Valuation

- Absolute Value: intrinsic value ==> what would you be willing to pay today for a security - Annuities: series of equal cash flows to be received over # of periods ==> C * ( 1 - PV Factor) / R + Recurring amount of the annuity + appropriate discount rate which depends on level of risk + Duration of the annuity + Timing of annuity - Perpetuities - PS: cash flows paid by an annuity last forever ==> if company pay same dividend each period this can be used to determine value of stock * P= Par value * fixed % / Required rate of return + must specify the dividend + must specify required return - Constant Growth Dividend discount model: CS + Economic return = ∆price + dividend income / Beginning price *** Div * (1+G) / ( R-G) ==> use CAPM to determine R + specify dividends ne year beyond the year in which you are determine the price + must include required return + must include constant growth rate of dividends + implies that the stock rice will grow at same rate as dividends + assumes required return is greater than the dividend growth rate otherwise formula won't work - DCF analysts: Sum of the PV of future cash flows - Relative Valuation Model: uses the value of comparable stocks to determine the value of similar stocks ==> price multiples are useful metrics to determine if stock is undervalue or overvalued + P/E ratio = Price / EPS in one year + Trailing P/E = Price today / EPS past year + PEG Ratio: Effect of earnings growth on a company P/E assuming linear relationships between P/E growth ==> lower PEG are more attractive to investors than stocks that have higher **** PEG = (P/E)/G ***** P = PEG * E * G + Price to Sales ratio = P ÷ expected sales + P = (P/S) * S **** Pg 33 and 36 of notes ****

Absorption approach VS Contribution Approach

- Absorption: Rev - COGS = GM - Operating Exp = NI - Contribution: REV - VC = CM- FC = NI *** Variable cost include DL, DM, VOH, shipping and packaging, and variable Selling *** FC included FOH, Fixed Selling, and most general and admin costs - CM VS absorption: difference in treatment of fixed factory OH + under absorption ==> included in inventory values as product costs + under CM ==> expensed in period incurred as period costs + SGA under Absorp ==> Variable and fixed SGA are part of operating expenses + SGA under CM ==> part of total VC for CM - Effect on income: if all production is sold every period, both methods produce the same operating income + If production is greater than sales: Ending inventory and income will be higher under ABS costing + Sales > production: Beginning inventory and income lower under absorption because fixed manful is carried over 1. compute FC per unit (FMOH/units produced) 2. compute the change in income (change in inventory units * FC per unit) 3. Determine the impact of the change in come *** No change in inventory ==> absorption = variable net income *** Increase in inventory ==> absorption > VC *** Decrease in inventory ==> absorption < VC

Enterprise Risk Mgmt Framework (ERM)

- Assists orgs in developing a comprehensive response to risk mgmt - manage risk and create value + Risk: Probability that events will occur and affect the achievement of strategy and business objectives + Value: Stock price increases or pay dividends * Creation: when benefit of value exceeds the cost of resources used * Preservation: ongoing operations efficiently and effectively sustain created benefits ( high customer satisfaction with profitable product lines) * Erosion: Faulty strategy and inefficient/ineffective operations cause value to decline * Realization: Benefits created by the org are received by stakeholders in either monetary or non monetary form + Mission, Vision, and core Values: Why / What / How -defines what an entity strives to be and how it wants to conduct business * Mission: Core purpose * vision: Goals * Core Values: ethics and culture - Culture: Collective thinking and shaping decsions - Capabilities: exploit the competitive advantages - Practices: continually applied at all levels of firm - Integration with Strategy-setting and Performance: Why do you exist and what is your vision / Strategy - Managing Risk Linked to Value: reasonable expectations and value creation depends on risk assumed which must be continually reviewed and managed to amounts the are acceptable + Risk Appetite: willingness to assume risk which can vary between products, business unites or over time so firms must be flexible + Relationship of Value and risk appetite: Directly related = risk assumed / expected returns

Option Pricing Models:

- Black Scholes Model ==> C = Stock price - PV of strike price - Binomial option model: discrete time period + useful for valuing American style options which can be exercised at any time or stocks that pay dividends + Assumed perfectly efficient stock + Security price will move up or down at certain points

Cash Flows Related to CAP Budgeting

- CF effects: accept if profitable: sum of future cash flows > todays cost + direct: pays out cash or receive cash + indirect: represents non cash activity that produces cash benefits or obligation (Deprec) ==> deprecated * T = dollar saved - Stages of cash flows: + inception: todays cost outflow both direct and indirect (shipping , training, installing) which is largest CF of investments life ==> offset initial outflow with proceeds in trade in * Additional WC ==> outflow * Reduced WC ==> inflow + Operations: future CF inflows ==> pretax cash inflows * (1-T) = inflow and Deprec * T = inflow + disposal of project ==> one time terminal year cash inflow ==> assets sold (Salvage value) ==> Severance pay ==> a WC commitment that was recognized as a indirect cash outflow at inception is recognized as indirect cash inflow at end of project when released - Pretax and after tax cash inflows: + Pretax ==> EBT and after tax ==> EBT * (1-T) = inflow **** pg 39 of notes ***

Cost of Goods manufactured and Sold - Production costs

- COGM: accounts for manuf cost of products completed during the period = Beg RM + Purchasing = AFU ==> ending inventory and used inventory

Keep or Drop a segment

- Classification of Costs: FC identified as either avoidable or unavoidable even if the segment is discontinued - Decision factor: compare FC that can be avoided to the Cm that will be lost *** pg 68 - Strategic factors: + impact on product addition or deletion on employee moral + Growth potential + opport costs associated with available capacity

Capital Structure Components: how to raise money

- Debt Financing: Fixed costs ==> interest exp risk increases but ROE increases + Commercial Papers: unsecured, Short-term (270 days or less) and must be used to finance current assets ==> avoids expenses of maintain comp balance with bank / provides broad distribution for borrowing / accrues a benefit to the borrower because become more widely known + Debentures: unsecured obligations of the issuing company (general creditor) + Subordinated Debenture: higher risk + Income bond: pays interest only upon achievement of target income levels + Junk bonds ==> higher default risk but higher return + Mortgage bonds: loan secured by real property with a trustee acting on behalf of bondholders + Leasing: don't borrow and buy but instead renting if lower cost Floating-rate bonds would automatically adjust the return on a financial instrument to produce a constant market value for that instrument. No premium or discount would be required since market changes would be accounted for through the interest rate Lessee get to use property In exchange for periodic payments * Operating lease or finance lease: result in the lessee recording ROU asset and a lease liab on B/S * Operating lease: lease exp representing the interest exp and amort of ROU asset * Finance lease: interest exp and amort exp are separately stated on IS ==> (Ownership/Written/NPV of all pmts equal or exceed FV / Economic life / Specialized asset no alternative uses) * Don't have to recognize ROU if 12 months or less - Equity Financing: variable costs with no maturity risks thus credit worthiness + PS: fixed dividend that is not tax deductible so it cost more than debt + CS: basic equity ownership with voting rights ==> nothin is fixed just variable dividend payments / lowest claims to asses upon liquidation

Tracing Costs to Cost objects

- Direct Cost: Easily traced + DM: Costs of materials ( freight in) ==> freight out is expensed and not capitalized ==> normal scrap is part of product cost and abnormal is a period cost + DL: directly related to production of a product or performance of a service plus a reasonable amount of expected downtime - indirect costs: not easily traceable in the factory ==> product OH / in the office ==> period (SGA) + indirect Material: cost of materials that were not used specifically or traced to completed product + indirect labor: cost of labor not easily traceable ( forklift drivers or maintenance) + Other indirect cost: depreciation / maintenance / property tax / utilities / rent **** Prime cost = DL + DM **** Conversion Cost = DL + Manuf OH - OH allocation using cost drivers: assign factory OH during period and allocate to individuals products + Allocation bases: Ex: historically every $ spent on DL we spent $ on OH + accounting for OH: traditional costing ==> all indirect costs are allocated to a single cost pool or allocated using activity based costing (multiple cost drivers) 1. OH rate = Budgeted overhead cost ÷ estimated cost driver 2. Applied OH = Actual cost driver * OH rate

COSO Internal Control Framework

- Effective system of internal control should provide reasonable assurance that entity will achieve its operating, reporting, and compliance objectives (ORC) and they are both present (design) and functioning (operating) as designed - 3 objectives: ORC + Operating: effectiveness and efficiency and assets safeguards + Reporting objectives: reliable, timeliness, and transparency of external and internal financial and non financial reporting + Compliance: adhere to all applicable laws and regs - 5 components: CRIME and 17 Principles ( EBOCA / SAFR / OIE / SOD / CATP + Control environment: Tone at the top (foundation to establish IC) *** EBOCA *** 1. commitments to Ethics and integrity ( std of conduct) 2. Board Independence and oversight (OVERSIGHT) 3. Organizational Structure: reporting lines / authorities / and responsibilities that are appropriate 4. Commitment to Competence: Hire / develop / and retain competent employees 5. Accountability: Establishing performance measures, incentives, and rewards + Risk Assessment: F/S misstated, not efficient, breaking law ( make entity (SAFR) 6. Specify objectives: ID and assess risk 7. Identify and Analyze Risks: How should we manage 8. Consider Potential for Fraud: Pressures, opportunities and attitudes/rationalization 9. ID and assess changes + Existing Control Activities: Policies nad Procedures to mitigate risks (detective or preventive) => segregation of duties => CATP: 10.. Select and Develop (Control Activities) / 11. (Technology Controls) / 12. (Policies and Procedures) + Information and Communication: Fair / Accurate / Complete / Timely (FACT => B/w internal and external parties (OIE) 13. Obtain and use info 14. Internally communicate info at all levels 15. Communicate externally using all channels of communication + Monitoring Activities: Effectiveness of controls and report deficiencies (SOD) 16. Ongoing and Separate evaluation whether components of IC are present and functioning 17. Communication of Deficiencies: Communicate IC deficiencies in a timely manner and corrective action is taken **** Picture on Page 3 of notes Outlines all this ***

Investment mgmt Strategies:

- Factors: inventory depends on the accuracy of sales forecast - Carrying costs are burdensome: + Storage costs + Insurance costs + Opport. Costs of inventory investments + Lost investory due to obsolescence or spoilage *** the lower the carrying costs of inventory, the more inventory companies are willing to carry - Optimal level of inventory: + inventory turnover + Safety stock : cushion that ensure manufactures or customer supply is met ==> reliability of sales forecasts ==> Possibility of customer dissatisfaction ==> stockout costs ==> Lead time ==> seasonal demands ==> Reorder point ==> safety stock + (Lead time * Sales during lead time ==> Economic order qty: Trade-offs between carrying costs and ordering costs (driven by frequency): Assumes periodic demand is known = sqr root(2*annual sales (units) * cost per purchase order)/ carrying cost per unit - other inventory issues: + Just in time ==> pull approach that reduces the lag time between inventory arrival and use but requires a degree of coordination between supplier and manufacture + Kaban inc ==> visual signal time to order

Business Cycle

- GDP ==> measuring economic activity + rise and fall of economic activity relative to long term growth that is not stable and characterized by fluctuations that vary in duration and severity + Macro ==> monetary and fiscal policies (gov wants to minimize deviations from LT growth) + Measures output of the economy and is the total market value of all goods and services produced within the borders of a nation regardless who owns the factories + Nominal GDP: Measured in todays prices thus skewed by inflation + Real GDP: measured ib base year prices ==> real GDP is most common measure of activity and national output ==> per capita is red to compare std of living across countries or across real time *** Real GDP = (nominal / GDP factor) * 100 - Summary of Business Cycles: + Expansion phase: increasing GDP, employment, and decrease in unemployment + Peak: high point marks end of expansion and firm is facing capacity constraints leading to higher costs thus corp profits decline as well as growth + Contractionary: falling GDP and employment because supply and output are going down ' + Trough: low point of economic activity where firm profits are at the lowest levels and corps are risk averse ==> a lot of downsizing and high unemployment + Recovery: economic activity begins to incr and return to its long term growth trend with demand for goods and services increasing - Common Terms: + Recession: Below LT growth and real GDP < potential ===> two consecutive qtrs of falling national output (decreases profits and capacity constraints) + Depression: very severe recession with stagnant business activity and high unemployment rates

5 Components (GOPRO) and 20 principles of ERM

- Governance and Culture: (DOVES) - Tone at Top + Defines desired culture - how conservative or aggressive are we + Exercise board oversight- Strategy and objectives + Demonstrates commitments to core values - adopt code of conduct + Attracts, Developments, and Retains capable individuals + Established operating structures - Centralized or decentralized - Strategy and Objective-Setting: (SOAR) + Evaluates alternative Strategies: more equity, less debt = less risk + Formulates business Objectives: realistic given risk assumed and must be measurable and attainable + Analyzes business context: considers external and internal environment + Defines Risk Appetite: suitable risks in qualitative (goal based) and quantitative (std deviation) ==> targets - Performance: (VAPIR) + Develops portfolio view: entity wide view of risk + Assesses severity of Risk: helps prioritize risk at multiple levels - Inherent (cyclical/demographics) / target residual risk (amount firm prefers) / actual residual risk (remaining risk after actions have been taken) ***** Residual Risk = Inherent risk - Impact of mgmt actions ******* + Priorities risk: interest rate risk / currency risk / competition risk + identifies risks: risk that affect performance + Implements risk response: ARTS: * Accept (self-insure): no action taken to change the severity * Avoid: Action is taken to remove risk * Pursue: Action taken that accepts increased risk to achieve improved performance * Reduce: Action taken to reduce severity of risk (hedging) * Share (Transfer: action taken to reduce the severity of risk (insurance) - Review and Revision: (SIR) + Assesses substantial change: Internal (change in personnel) or external (substitute products) + Pursues improvement in ERM: opportunities to revise and improve efficiency and usefulness + Reviews risk and performance: were actions effective - Ongoing Info, Communication, and reporting: (TIP) + Leverages info and technology: Fair / Accurate / complete / timely + Communicates risk information: internal and external + Reports on risk, culture, and performance: * Portfolio view of risks: entity level * Profile view of risk: at different level pithing the entity ( subsidiarily / product line) *** PG 9 of notes has chart **

Profitability ratios

- Gross margin: (Sales - Cogs) ÷ Sales - Profit margin: NI ÷ Sales - ROE = NI ÷ avg equity + the higher the better - ROA = NI ÷ avg Assets + higher the better ==> generating more profits relative to its base assets

Growth and Profitability

- Growth rate = (Return on assets * Retention) ÷ 1 - (Return on assets * Retention) *** Retention = 1- payout - Profitability: Success of a company ==> higher the better +ROS = income before interest income, interest expense, and taxes ÷ sales (net) + ROI= NI / Average invested capital (A - op liab) + ROA = (Net income / AVG total assets) + ROE = (NI / Avg total equity)

Corp Banking Arrangements

- Letter of Credit: Lower cost of borrowing ==> third party guarantee / represent an external credit enhancement used by a company issuing otherwise unsecured debt to enhance its credits or required by creditors - Line of credit ==> bank loans - Borrowing capacity: increases if you have a low debt to equity ratio ==> income levels and stable earnings / both lenders and borrowers have to manage their risks and borrowing capacity - Debt Covenants: Protects the borrowers credit rating ==> reduces cost of borrowing + Creditors make this to prohibit action of debtors that may affect position + common negative (limitations) and positive covenants ( providing stuff) + Violation of covenants can immediately result in demand of repayment of entire principal

Valuing intangibles

- Market Approach ==> recent sale of similar asset - Income approach ==> discounted CF approach = sum of PV of cash Flows - Cost Approach ==> replacement approach

Risks Identified using COSO

- Material Omission or Misstatement: unintentional ==> risk that can individually or combined result in MM + Multiple industries, markets, and geo areas + multiple reg environments + Transactional environments with numerous contracts - Fraud: intentional misrepresentation: + theft of assets + unethical estimates and judgements + Mgmt Bias + Incentives for Fraud + Attitudes and rationalization + unusual transactions + IC ==> designed and implemented to detect or prevent timely manner any material omissions due to error or fraud but not all omissions - MGMT override of controls: for personal gain - Illegal Acts: violation of government regs + Existence of investigations + reports of regulatory examiners + payments for unspecified services + Delinquent Tax returns

Cash and Credit Mgmt

- Mgmt of Cash and equivalents: + Transaction motive: meet payments arising from ordinary course business + speculative motive: cash may be needed to take advantage of temp opportunities. + Precautionary motive: Have enough cash on hand to maintain a safety cushion to meet unexpected needs - Primary method of increasing cash: reduce operating cycle ( sell quickly and collect quickly) / speed up inflow or slow outflows - Managing AR: + Credit policy: 1. Credit period ==> length time buyer given to pay 2. Credit Standards ==> extend credit ti only financially string consumers 3. Collection policy + Factoring: Turning over the collection of AR to a third party factor in exchange for a discounted ST loan. Cash is collected from factor immediately rather than from customer according to credit terms

Mitigating and controlling Transaction exposure

- Net Transaction Exposure: if AR > AP net asset risk FC decreases and if AP>AR net liability risk FC increases + Selective hedging: various derivative instruments that seek a risk in the opposite manner of the hedged item ( Forwards, Futures, Options, and Swaps) + ID Exposures: Accumulate inflows(Exports) and outflows (imports) of FC / Consolidate the effects on sub by currency type / compute net effect in total - Mitigating Transaction exposure: Future Hedge: Exchange traded that allows holder to either purchase or sell a number of currency units for a price on a stated date denominated in standard amounts and used for smaller transactions + AP application: net liability and the risk is that the FC will go up in value: Buy calls / Buy future contracts / Futures hedge (buy FC to mitigate the risk of a weakening domestic currency) + AR Application: net asset and the risk is the FC will decrease in value: (Buy put options / Sell futures contracts / Future hedge contract to sell FC to mitigate the risk of a strengthening domestic currency) - Mitigating Transaction Exposure: Forward Hedge: similar to future hedge but are contracts between business and commercial banks and are for larger transactions + AP Application: net liability with the risk that FC will go up in value: (Buy call options /Buy forward or Future contracts) + AR Application: net asset with the risk that FC will go down in value: (Buy put options /Sell forward or future options) - Money Market Hedge: use of international money markets to plan to meet future currency requirements. it uses domestic currency to purchase FC at spot rates and invests them in sec. timed to mature at same time payables + AP excess cash: excess cash use money market hedge to lock in exchange rates needed to satisfy payable: (Determine payable amount / interest earned prior to settlement / discount amount of payable to net investment required / purchase that amount of FC equal to investments required and deposit the proceeds in appropriate money market vehicle) + AP Borrowed funds: borrow in domestic dollar to buy FC today + AR: Factor recevables with foreign bank loans - Currency option Hedges: Buy Call ==> put cap on costs / Buy put ==> put floor on Rev + Payables: Buy call options / Buy forward or future contracts + Receivables: Buy Put options or sell contracts - Mitigating Transaction Exposure: LT Transactions: Forwards or Swaps - Leading and Lagging ==> related parties + Leading: bill in advance + Lagging: wait until the exchange rate is favorable **** Pg 20

Valuing Debt Instruments

- Value of a bond is equal to the present value of its future cash flows discounted using single rate or multiple rates aligned with degree of risk

ROA

- Net income ÷ Avg total Assets ==> the higher the better - ROE / ROA issues: the higher the denominator used on ROI the lower the return + Variation on asset valuation: 1. NBV : skewed by age and method of depreciation 2. Gross book value ==> historical cost but skewed by age 3. Replacement cost ==> not skewed and value will increase but ROI will decrease 4. Liquidation Value ==> bankruptcy cases + limitations of ROI: thus residual income may be superior measure of performance *** Provides incentives but: 1. has short term focus (manager purely want to maximize ST returns to increase pay) 2. Disincentive to invest ==> could reduce ROI in ST if invest in additional productive resources

Activity Based Accounting

- Operational costs: + volume: total manuf OH / Est total hrs = OH rate + Activity based: uses multiple cost pools and rates to assign OH to products ==> assumes the best way to assign indirect cost to products is based on the products demand for resources-consuming activities - ABC: value added activities increase the product value or service + cost drivers ==> closely correlated with incurrence of manuf OH ==> high correlation coefficient + advantages ==> ABC will apply high amounts of OH to product that places high demand on expensive resources *** pg 50 *** - Service costs allocation using ABC: all sectors of economy can use ABC by allocating service department costs to production or user department and final products produced + direct method: each service department total cost is directly allocated to the production department without recognizing that dept. themselves may use services from other dept + Step Down: service dept cost are allocated to other service dept as well as production dept

Financial Budgets: Cash

- Projections of cash receipts and disbursements - Cash available ==> cash at beginning and cash collections + amounts on hand limited by mgmt policies + cash collection ==> cash that will be received by sales based on anticipated loan proceeds - Cash Disbursements: Cash outlays associated with purchases and with operating expense + Purchases: cash and credit purchases in current period and payables we are paying off this period + operating exp ==> eliminate non cash op expenses and include % of prior month exp paid this month and current month exp deferred until following month or paid this month - financing: used to maintain min cash balance with excess or idle cash will be invested - Cash budget format= Beginning cash + cash collections from sales - disbursements for purchases and op exp = computed ending cash - cash requirements to sustain operations - WC loans to maintain cash requirements

Master budget

- Provide comprehensive and coordinated budget guidance for an org consistent with overall strategic objectives - Anticipation of achieving a single level of sales volume for a specific period - Operating budget ==> describes the resources needed and the manner in which those resources will be acquired ==> sales budget / production budget / personnel budgets - Financial budget ==> detailed sources and uses of funds (pro forma FS / Cash budgets

Return on Equity and the Dupont Model

- ROI ==> stockholder perspective: NI / Equity + Stock value will increase if ROE > required rate on equity + provide mgmt with clearer pic of the efficiencies and leverage of a given operations - Dupont Analysis: what is driving RO + Net profit margin: NI/Sales + Asset Turnover: Sales / Assets ==> if A is too low, sales decreases and ROE decreases ==> if assets too high, turnover will decrease and ROE will decrease + Financial leverage: dependent on mgmt level of risk aversion ==> assets / Equity + Dupont ROE = Net profit margin * Asset Turnover * Financial Leverage or ROE * financial leverage + Extended Dupont model: (Tax Burden * interest Burden * EBIT margin * Asset turnover * Financial leverage ) ==> Tax burden = NI / Pretax income ==> interest burden= pretax income / EBIT ==> EBIT margin = EBIT / Sales (dependent on competition and power of suppliers)

financial scorecard

- Responsibility segments: strategic business units classified in 4 financial measures + cost SBU: lowest level that controls cost + Revenue SBU: managers responsible for generating revenue + Profit SBU: account for both revenue and costs + Investment SBU: highest level that board is responsible for: produce earnings generated by SBU - Areas of Accountability: Each SBU is subdivide into additional areas of accountability: (product line / Geographic area / customer) - Contribution reporting: profit SBU normally responsible for generating a level of profit in relation to a controllable cost + CM ==> selling price - VC + controllable margin ==> CM - controllable FC + allocation of common costs ==> not controllable - Balance scorecard: FICA ==> financial / internal business process / Customer satisfaction / advancement of innovation and human resource development /(learning and growth)

ERM Themes and Terms

- Risk inventory: economic, societal, demographics, and legal - Reasonable expectations: take on risk that is appropriate and core values will affect the amount of risk orgs willing to accept - Business Context: trends, events, relationships, and other factors that may influence (economically and industrially) - Risk Capacity: suitable or tolerance of risk ( max. level of risk we can assume) - Risk profile: risk assumed at a particular level of entity (product line / area / customer) - Portfolio View: holistic view (are we diversified) / risk the entity faces - Organizational sustainability: ability to withstand the impact of large scale events - Performance mgmt: measurement either quantitative or qualitative ==> performance / customer satisfaction

Ineffective IC

- Risk that ORC not achieved will increase + Major deficiencies: deficiency that significantly reduces the likelihood that an org will achieve its objectives and results in mgmt not concluding they have effective IC under COSO - IC Limitations: inherent limitations exists even in an effective system: + Human error + Faulty or biased judgement in decision making + suitability of objectives + External events + Collusion + Management override

Trade Offs between Risk and Return

- Risk: Chance of financial loss or uncertainty or variability of returns - Return: the greater the risk yields higher returns - Risk Preferences: + Risk indifferent: increase in level of risk does not result in an increase in mgmts. Required rate of return + Risk adverse: increase in a level of risk results in a increase in mgmts. Required rate of return + Risk-seeking: increase In the level of risk results in a decrease in required rate of return

Job-Order costing

- When relatively few units are produced and each unit is unique - Cost objective is the job ==> cost is allocated to a specific job as it moves through the process - Job cost record: material requisition / labor time / job order costing **** pg 44 of notes has a good picture / flow chart)

Financing Decisions and WC

- ST Financing: companies use a mix of ST and LT financing to meet capital requirements + Rates ==> tend to be lower + ST requires current assets to be sufficient to meet needs + increase profitability + decrease fin. costs + increases interest rate risk + decrease capital availability - LT financing: + Rates ==> tend to be higher + WC ==> the extent of LT depends on both the amount of current assets and risk tolerance of mgmt + increases financial leverage + decreases interest rate risk + decreases profit + increases costs

Specific requirements to be considered effective IC

- Senior mgmt and BOD must've reasonable assurance that the entity: + Achieves effective and efficient operations when: * External threats are considered unlikely to impact objectives * Org can reasonably predict and mitigate Threats + Understands the extent of operations are managed effectively and efficiently when: * Threats may impact objectives * org can predict and mitigate these threats to an acceptable level + Complies with all rules, regs, standards, and laws + Prepares reports that are in conformity with the entity's reporting objectives and all applicable stds, regs, laws

regression analysis

- Simply Regression: involves one independent variable while multiple involves more than one y = Mx+B * y is total cost and x is total activity or output - Statistical measures: + Coefficient of correlation: Strength of linear relationship ==> R ranges from -1 to +1 with 0 being no correlation ==> projecting total costs: cost model will usually be between 0 to +1 + Coefficient of determination (r^2) ==> proportion of total variation in the dependent variable explained by the inmdepndt variable ==> the higher the R ^2 the better the fit

Operational and tactical planning

- Single use plans ==> apply to specific circumstance during a specific time frame - Annual budget ==> translates the strategic plan and implementation into a period specific operational guide

Variance analysis using standards

- Std Costing system ==> measures the cost the firm expects that it should incur during production + production costs subject to variance analysis ==> DM / DL / VOH / FOH + DM and DL ==> price and qty variance *** DM Price variance = Actual qty purchased * (actual price - std price_ *** DM qty usage variance ==> std price * ( actual qty used - std qty allowed) *** DL rate variance = actual hrs worked * ( actual rate - std rate) **** DL efficiency variance = Std rate * ( actual hrs worked - std hrs allowed ) - Manuf OG Variance + VOH rate (spending variance) = actual hrs * (actual rate - std rate) + VOH efficiency variance = Std rate * ( actual hrs used - std hrs allowed for actual production volume) + FOG budget (spending) = Actual FOH - Budegted FOH + FOH volume variance = Budgeted FOH - STD FOH allocated to production 1. calc OH rate = Budgeted OH cost ÷ estimated cost driver 2. Applied OH = Std cost driver for actual level of activity * OH rate **** 76 *** - Sales and CM variance + Sales variance = {(Actual SP/units) - ( budgeted SP / units)} * actual sold units + Sales volume variance = {(actual sold units - Budgeted soled units) * std contributions margin per unit)}

SOX act of 2002 Title III

- Title III (Corp Responsibility): + Public Company Audit Committees: responsible for appointing, compensating, oversight of the work of the public accounting firm employed by that company * auditor reports to audit committee * responsible fore resolving disputes b/w auditor and mgmt * must be members of the issuers Board but are independent * establish proceeds to accept reports of complaints regarding audit, accounting, or internal control issues + Corp Responsibility for financial reports: CEO and CFO must sign that qtr and annual reports with assertions that: They review reports / they contain no misstatements / they are fair / IC are designed, evaluated, and concluded to be effective / all significant deficiencies and material weaknesses in design and operation of controls are reported ***IC must be evaluated 90 days prior to issuing reports **** + improper influence on the conduct of Audits: Must Cooperate + Forfeiture ofCertain Bonuses and Profits: if issuer is required to restatement due to material noncompliance, the CEO and CFO may be required to reimburse company for bonuses or incentives based comp or on sales of securities during that 12 month period

SOX act of 2002 Title IV

- Title IV (Enhanced Financial Disclosure): + Disclosures in periodic reports (Annual or Qtrly): * all material corrections * all material off-balance sheet transactions (lawsuits, op leases, and unconsolidated entities) * conformance of pro forma F/s + Conflict of interest provision: Issuers are prohibited from making personal loans to directors or executives outside of ordinary course of business + disclosure of Transaction involving mgmt and principal stockholders: Transactions with SH who one more than 10% + Mgmt Assessment of IC: Section 404 annual report is required to contain a report that includes: * stmt that mgmt is responsible for establishing and maintaining IC * assessment as of end of year effectiveness of IC with an attest stmt from auditor + Code of Ethics for senior officer: Tone at top * Must disclose whether the issuer has adopted a code of conduct for officers and if no code the issuer must disclose the reasons * Code of conduct promotes honest and ethical conduct / full, fair, accurate, and timely disclosures / compliance with rules and laws + Disclosure of Audit Committee Financial Expert: one member of committee must disclose the existence of expertise or the reason why committee does not have a member * financial expert: education / past experience / CPA * knowledge of financial expert should include understanding and application of GAAP and experience with IC + Enhanced Review of Periodic Disclosures by issuers: SEC is required to review disclosures made by issuers on a regular systematic basis for protection of investors by considering the past material MS or significant volatility in stock price, large market cap, issuers whose operations can affect a sector of economy

Accounts Payable mgmt

- Try to spread payments out unless you can take advantage of vendor discounts ==> provide the largest source of ST credit for small firms - Calculating Discounts: 360/(Pay period - discount period) * (Discount ÷ (100 - discount %) + Discount factors: there can be high cost associated with a customer not taking advantage of discounts ==> does company have cash on hand or do they want to preserve its cash position - Use of electronic funds ==> Expedite deposits, thus $ balance increases - Optimal vendor pmt schedule ==> stretch it out as long as you can so you can reduce your cash conversion cycle - Methods of delaying disbursements ==> allows cash balance to increase + Defer pmts + Line of credits = bank loan

Joint Product Costing and By product costing

- allocating cost of single process among several final products if two or more final products are produced from same raw material or input - Joint product ==> main product - By product ==> incidental - Split-off point ==> point which joint product can be recognized as individual products - joint product cost ==> cost up to split off point - Separable costs ==> cost after split off point - Relative NRV at split off point: + Sales price quotations available at split off ==> sales values at split off can be used to allocate joint costs if known + if not available ==> sales value at split-off = Final selling price - identifiable costs incurred after split-off - Service department cost allocation to joint products: by using the joint products unit-volume relationship - By products: relatively minor value ==> low sales value that is not sufficient to cover common costs + applied to main product ==> reduction to common costs + or it can just be credited to misc income on IS

ROI

- income / Investment Capital ==> avg assets or avg PPE + Avg WC OR - Profit margin * investment turnover ==> (NI÷S)*(S÷A)

Mitigating and Controlling financial risk

- must not only identify and assess various risk but also implement strategies to mitigate the impact of these risks + Diversification: process of building a portfolio of different and offsetting risks + Strategies to mitigate and control financial risk: - Interest rate risk: investing in floating rate debt securities or derivatives (forwards and Swaps) where investor pays a fixed rate and receives a floating interest rate - Market risk: non-diversifiable but controlled by investing in derivative that can be short sold - Unsystematic risk: minimized through diversification - Credit risk: ratio analysis - how to reduce cost of borrowing: improve credit rating which is based on economic outlook, industry conditions, cash flow measures, leverage, cap structure - Default risk: chose to lend money to only those borrowers with low risk of default or to adjust interest rates charged to better reflect the risk of the borrower - Liquidity Risk: mitigated by allocating a greater percentage of capital to investment that trade on active markets - Price Risk: minimized through diversification and hedging through short selling or derivatives: buy put option if P decrease can use profit on put to offset loss in value *** pg 16 + 17 ***

ratio analysis

- numerator has a direct relationship with the ratio so if its increasing the ratio itself will increase and vice versa - denominator has an inverse relationship

Optimal Capital Structure

- ratio of debt to equity that produces the lowest WACC ==> rate of return fluctuates as debt to equity changes + Capital Budgeting: the historical WACC may not be appropriate. for discount rate for a new cap project unless the project carries the same risk a the corp and results in identical leveraging characteristics

Loan Covenants and Cap Structure

- used by lenders to protect their interests by prohibiting the actions of borrowers that might negatively affect their positions as a lender ==> if heavily weighted toward equity, dent covenants are not difficult to maintain but if heavily debited then it can be challenging

Discounted CF

- using Time value of money to measure PV of cash inflows and outflows - Required rate of return ==> hurdle rate or compensation for risk assumed ( WACC or specific rate to risk) - Limitations: using a single rate assumption is often unrealistic because risk and rate fluctuates which makes NPV better than IRR

Costs of Quality

APIE ==> Conformance and Nonconformance (inversely related) - Conformance: + Appraisal: detect a problem before it gets to a customer or next dept ==> quality checks / testing / inspection + Prevention: prevention costs are incurred to prevent a defective unit ==> training and inspections - Nonconformance costs: many of these costs are in the form of opportunity cost + internal Failure: cure a defect discovered before the product is sent to the customer ==> rework costs / scrap + external failure: cure a defect after the product is sent to customer ==> warranty / cost of returning / liability claims / lost customers - Quality Reporting: increased investment in conformance costs should result in decrease in nonconforming costs

Currency Exchange Rate Risk

Factors: - Trade: + relative inflation rates: Purchasing power ==> currency with higher inflation loses value thus demand for that currency value + Relative income levels: increased demand for foreign currencies in the country in which income is increasing (as demand goes up value goes up) + Government Controls: artificially suppress the nature forces of supply and demand will affect exchange rates - Risk Exposure Categories: + Transactions: potential that an org could suffer gains and losses upon settlement of individual transaction as a result of exchange rate changes ==> A/R denominated in FC decreases thus AP increases causes a loss ==> AP denominated in FC increases thus AR increases causes a loss ==> Measure by: projecting foreign currency inflows and outflows then estimating the variability risk associated with currency * Economic Exposure: Potential that the PV of an orgs cash flows increase or decrease as a result of changes in exchange rates: + Effect of domestic currency appreciation: (AR decreases ==> PV cash in Decreases results in loss) / (AP Decreases PV cash out decreases results in gain) + Effect of currency depreciation: (AR incr cash in incr resulting in gain) / (AP increases cash out increases resulting in loss) * Translation exposure: risk that assets, liabilities, equity, or income of a consolidated org that includes foreign subs will change as a result of changes in exchange rates: Exposure incr in proportion of foreign involvement by sub increases and the more stable the exchange rate is the lower the risk but more volatile the exchange rate the higher risk

Actual vs. Plan

Helps compare some measures of performance to a plan, budget, or standard for that measure - Performance reports: usefulness is limited by the existence of budgeted variance that may be strictly related to volume PG 74 +75 - Use of Flex budget ==> allows managers to ID how an individual change in a cost or revenue driver affects the overall costs of a process

Debt Ratios

How company employs financial leverage ==> debt is cheaper (tax benefits and lower int rates) but too much is risky - Debt to equity: total liabilities / total equity + higher indicates company employs more risk so want to choose best mix to minimize cost of capital - total debt = Total liabilities / Total assets + risk increases as ratio increases - Times interest earned ( coverage ratio) = EBIT ÷ interest expense + higher the better but too high indicates we aren't funding enough. by paying down old debt or replacing with new carrying low rate can lower int exp in future and incr ratio

Special order decisions

Opportunity that require a firm to decide whether a specially priced order should be accepted or rejected - Determining relevant costs: + presumed excess capacity ==> incremental costs of the order to the incremental revenues generated by the order + presumed full capacity ==> opportunity cost of producing should be included *** pg 66*** - Strategic Factors: + Effect on regular priced sales + Future Sales to this customer + pricing of special order + Etc

Financial budgets: Pro forma F/s

Pro Forma Stmt: Sales Budget / COGS budget / SGA budget / Interest exp budget

NPV

Profit/loss ==> sum of PVCF - Costs - Evaluates return in dollar amounts - NPV is the dollar change in the market value of the firms equity due to the project - if positive ==> invest and infer that the IRR is greater than hurdle rate and PI is greater than 1 - if negative ==> do not make investment - Interest rate adjustment is required for NPV for risk and inflation but not IRR determine by mgmt - Differing rates for different periods to reflect a greater risk - Calculating: 1. calc after tax CF ==> net CF * (1-Tax) 2. add depreciation benefit ==> Deprec * T 3. multiply result by appropriate PV of annuity assuming constant CF 4. subtract cash outflow **** Pg 40**** - Advantages: measures P/L inflows - Limitation: Doesn't provide the true rate of return on the investment - Capital Rationing: how limited investment resources are considered as part of investment rankings and selection decisions ==> unlimited ( NPV infer IRR > hurdle rate / Limited ==> mutually exclusive and use NPV - Profitability index (Bigger the better) ==> PV of CF ÷ PV cost of intial investment ***pg 41 ***

Operating budgets

Sales budget ==> the foundation - Sales budget based on the sales forecast + Past patterns of sales / Sales and force estimates / general economic conditions / competitors actions - Budgeted Sales + Desired ending inventory - Beginning inventory = Budgeted production *** pg 70 - DM budget (purchase budget) = units of DM needed for a production period + desired ending inventory - Beginning inventory at start of period + cost of DM to be purchased = units of DM to be bought * cost per unit + usage budget = BB + purchases at cost - Ending inventory at costs = DM usage (cost of material used) - DL budget = Budgeted production (in units) * hrs required to produce each unit = total # of hrs needed * hourly wage rate *** pg 71 - Factory OH Budget: applied to inventory based on representative statistic - COGM and sold Budget = COGM + BB of finished goods - EB of finished goods = COGS *** 73 - SGA expense budget: Variable SGA and Fixed SGA + need to be detailed in order that the key assumptions can be understood -

Breakeven Analysis

Sales required to achieve a zero profit or loss - Breakeven points in units: * Breakeven point in units: (Total FC / CM per unit ) - BE in dollars: * Unit price * BE point in units * (Total fixed costs / CM ratio) - Required Sales volume for target profit = Sale(units) = (FC + pretax profit)/ CM per unit * Sales dollars = VC + FC + pretax profits *** (FC + Pretax profit) / CM ratio - Predicting profits based on volume: units above BE * CM per unit - Setting selling prices based on assumed Volume = Margin of safety $ = Total sales - BE - Margin of safety % = margin of safety $ ÷ total sales

Make vs. Buy

Select the lowest cost alternative: - Excess capacity ==> cost of making the product is the cost that will be avoided if product is not made - No excess capacity ==> price is cost to make plus opportunity cost of alt decisions *** pg 67 - Strategic factors: + quality of the product purchased compared to product made + reliability of purchased product + value of service contracts or warranties

Standard Budgeting

Set below expectations to motivate productivity and efficiency - Ideal standard: cost that results from perfectly efficiency and effectiveness + adv ==> continus improvement + disadvantage ==> demotivates employees - Currently attainable: cost resulting from work performed by employees with appropriate training and experience + adv ==> perception that standard are reasonable + disadvantage ==> use of judgement and manipulation - Authoritative and participant standards: + implanted quickly and include all costs + workers might not accept though + participant ==> worker more likekly to accept but is slower to implement

Economic Value added

WACC is the hurdle rate and is more at a firm perspective - Economic value added = Net operating profit after taxes - required return + RR = investment * WACC +NOPAT= EBIT * (1-T) + interest bearing debt + equity ==> total assets - Positive EVA==> stock price will increase - Negative EVA ==> stock and firm value will go down - Can be refined by using investments or income adjustments to produce more accurate analysis of economic profit - investment valuation issues: + Capitalization ===> increase NI and Assets + Current valuation - income determination ==> adjustments to the BS affect IS and deferred taxes are ignored *** pg 58

Weighted Avg cost of capital

WACC: Avg cost of all forms of financing used by a company that is used as a hurdle rate for capital investment decisions ==> lowest WACC creates the optimal capital structure - Firm Value = FCFF/WACC - WACC Formula Pg 23 of notes - WACC if Debt: lenders required return dictates to borrower costs of borrowing which carries lowest cost go capital due to tax deduction *** Weighted avg interest rate = Effective interest pmts / debt outstanding **** + As tax rate increases the cost of debt will decrease - Cost of Preferred stock; higher cost then debt because dividends are not deductible and PS assumes more risk - Cost of RE: Cost of PE - CS last in line ==> assumes the most risk + equals the rate of return required by the firm CS holders + Three methods to calc: 1. CAPM = RF + Beta *(RM-RF) ==> if beta is more than 1 then stock is more volatile then market ==> calc as % of change in stock price ÷ % change in market price 2. DCF ==> (Dividend / Current market price) + growth rate 3. Bond Yield plus risk premium: Pretax cost of LT debt + Market Risk premium ==> equity and debt are comparable before taxes

Types of Risk

o Interest rate risk (yield risk): as interest rates goes up the value of fixed income goes down ==> fluctuations in the value of instrument in response to changes in interest rates o Market/systematic/nondiversifiable risk: fluctuations in value as a result of operating within an economy ==> risk inherent in operating within the economy (war, inflation, international incidents, and political events) o Unsystematic /Firm-specific / Diversifiable Risk: nonmarket portion of a firms or industry's risk that is associated with random causes and can be eliminated through diversification (lawsuits, strikes, loss of a key account ) o Credit Risk: cost of borrowing as credit risk goes up the cost of borrowing goes up ==> inability to secure financing or secure favorable credit terms as a result of poor credit score o Default risk: affects lenders and it is the possibility that the debtor will not repay the principal or interest due on their indebtedness on a timely basis o Liquidity risk: lenders or investors are exposed to liquidity risk when they desire to sell their security but cannot do so in a timely manner or when material price concessions have to be made o Price risk: risk that investor has to a decline in the value of their individual securities or portfolios ==> factors unique to investment contribute to this risk and are diversifiable

Computation of Reurn (YIELD)

o Stated (annual) Interest Rate: also referred to as nominal rate that is charged before any adjustments for compounding or market factors ==> no math involved o Effective Interest Rate: represents the actual finance charge associated with a borrowing after reducing loan proceeds for charges and fees related to loan + Computation: Interest paid per period ÷ Net proceeds of loan o Annual Percentage rate: APR is the effective rate times the # of period in a year + Represents a noncompounded version of the effective annual percentage - Effective Annual % rate: stated interest rate adjusted for the number of compounding periods per year ****** [1+(i/p)^p] - 1 **** - Simple Interest ( amount): amount represented by interest paid only in the original amount of principal without regards to compounding + Principal * R * N - Compound interest (Amount: P * (1+R)^N + based on the original principal plus any unpaid interest earning or expenses - Required rate of return: the sum of all risk free rates: + Maturity Risk Premium: risk increases with term to maturity + Purchasing power risk or inflation premium: used to calc nominal risk free rate + Liquidity risk premium: risk investment cant be sold + Default risk Premium: risk issuer will fault pay

Activity Ratios

used to asses how efficient a company is utilizing its resources to generate sales and profits (turnover ratios tend to use Avg balances for BS components) - Days in inventory = EI ÷ (COGS / 365) + lower the days means efficient in converting inv to sales - days Sales in AR ==> Ending AR ÷ (Sales / 365) + shorter days means company is good at collecting - Days in AP = AP ÷ (COGS/365) + if company wished to conserve cash it will project long avg time periods to pay vendors - Cash Conversion Cycle = Days in inv + days in AR - Days in payable + the lower the better because company wants to minimize number of days in takes t convert inventory into sales and sales into cash while taking time to pay vendors