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Managerial accounting

March 20, 2018

Tonight I start teaching a managerial accounting MBA course at Fairleigh Dickinson University. [You can call me Professor Mendlowitz]. My opening remarks will be to distinguish managerial accounting from financial and cost accounting and I would like to share this with you here.

Financial accounting
Financial accounting goes back to the Sumerians who created the first human writing about 5500 years ago. Their cuneiform inscriptions kept track of farm production for workers probably paid on a piecework basis. Financial accounting precedes poetry and prose and writing for pleasure or communication – it is the first seed of civilization. The first financial records created history; before then everything was considered prehistoric! Financial accounting records what was. Financial accountants produce or audit the financial statements we eagerly read when they arrive; and the statements follow voluminous rules that must be adhered to under the banner of generally accepted accounting principles and auditing standards.

Cost accounting
The purpose of cost accounting is to provide the right method of measurement so that costs are captured, and then reformulated into usable information by many departments within a company. Cost accounting lets you make better decisions and is used by production workers, schedulers, managers, and the purchasing, inventory control, process improvement, accounting, shipping, sales and many other departments as necessary. And each user will look at the information differently. Cost accounting is a backward looking process and while it is used to determine pricing, budgets and projections, these are implemented and measured by historic costs.

Managerial accounting
Managerial accounting uses financial information to interpret trends so that decisions can be made. While much of the information used is backward looking, the purposes are forward looking. Managerial accountants try to synthesize all the inputs into actionable processes to create greater revenues and profits. Managerial accounting includes budgeting, what if scenarios, performance measurement analyses and charting potential results of resulting changes.

Actually, I taught this course almost 40 years ago, also at FDU, and its purpose then was to teach the future managers and leaders how to generate the reports. Today’s course focuses on the users and the decision support information they will need and will use in today’s dynamic fast changing 24/7 global business environment. It is a forward looking program that I am excited about and looking forward to teaching and sharing my experiences collaborating with managers, leaders and directors and helping to guide them in their decision making process.

The Ides of March

March 15, 2018

Julius Caesar was assassinated on March 15, 44 BCE, or famously the Ides of March as the opening words of Shakespeare’s Julius Caesar records. I wonder what day it was when the soothsayer warned Caesar to “beware the Ides of March.” Perhaps it was at the beginning of March but since the assassins needed time to plan the murder they more likely started the planning the previous Summer during the period Caesar was escalating the consolidation of his power. Either way, the date he died will live in history because of Shakespeare.

Gaius Julius Caesar was born on July 13, 100 BCE so he was 55 when he died. He was a Roman politician and general who played a critical role in the demise of the Roman Republic and the rise of the Roman Empire. He is known to have said “I came. I saw. I conquered” after a short war in 47 BCE. One of those succeeding him was Mark Antony also made famous by Shakespeare.

Much of what we know about Caesar is from two books he wrote chronicling the Galic and Civil Wars which are his only work to have survived in their entirety; and then republished as one of the first printed books in the late 15th Century. These were written by Caesar in the third person to give the impression of an objective history rather than the personal memoirs that they were. Other contemporary writers were Cicero and Sallust and later biographers Suetonius and Plutarch. Because of how much we know of him and his accomplishments, he is considered by many historians to be one of the greatest military commanders in history.

In 60 BCE he formed the first triumvirate to govern with Crassus and Pompey. Crassus was killed in battle in 53 BCE and Pompey assassinated in 48 BCE. In 47 BCE Caesar defeated the pharaoh’s forces and installed Cleopatra as ruler. Cleopatra also visited Rome more than once and reportedly Caesar had a son with her.

Caesar’s military exploits pushed the Roman Empire north to the English Channel and the Rhine invading Britain. That concluded the Gallic Wars and the Senate ordered him to resign his military command and return to Rome. His response was to cross the Rubicon [reportedly saying “the die is cast”], leaving his province and illegally entering Roman Italy under arms igniting a civil war which he won.

With complete unmatched power to govern Caesar instituted many social and governmental reforms. One was the creation of the Julian calendar with a 365.25 day year with an added day at the end of February every four years. He also had extra months inserted to align the calendar with the seasons, one of which was eventually named in his honor – July. Among his accomplishments were laws reforming debts, redistributing public lands to the poor, pardoning most of his enemies gaining their loyalty and support, and enacting a new constitution that brought order in the provinces and the Republic. He established a strong central government, reduced corruption by public officials; ordered a census, changed the way jurors were selected, passed laws restricting the purchase of certain luxuries, rewarded families for having many children to speed up the repopulation of Italy, outlawed certain professional guilds, set a term limit for governors, had the Forum of Caesar and many other public works built, distributed land to veterans, established a police force, started rebuilding Carthage and Cornith, and abolished the tax system reverting to an earlier version where cities made their own rules to collect taxes. His assassination also halted his plans to establish a library on the scale of the one in Alexandria. Further, Caesar increased the Senate by appointing hundreds of his loyalists thereby reducing the power and prestige of the sitting Senators. One month before his assassination he had himself appointed dictator for life.

The assassination was by rebellious senators led by Gaius Cassius Longinus and Marcus Junius Brutus. 60 senators participated in the assassination stabbing him 23 times with likely only one lethal blow.

Caesar’s grandnephew Gaius Octavius, later known as Augustus Caesar, was his principal heir. Caesar also bequeathed substantial gifts to the citizens of Rome. Civil War and more intrigue occurred afterwards, and if interested, I suggest you start at Wikipedia where I also got a lot of the information here.

Shakespeare’s play has some memorable quotes which appeared in a blog I posted on August 19, 2014. I also posted a blog with the same title as this on March 13, 2012, but that one wasn’t really about Julius Caesar. I hope you found the above interesting.

P.S. The Julian calendar was in use until 1582 when Pope Gregory XIII refined and replaced it. The actual number of days in a year are 365.2425 and the Gregorian calendar fixed this by adding 13 days since one day was lost every 128 years. The difference now is one day every 3030 years and this was accounted for in the Gregorian calendar that keeps track of it. The British Empire adopted the Gregorian calendar on September 14, 1752 and also made a change moving New Year’s Day from March 25 to January 1 advancing the calendar one year. Thus George Washington’s birthday of February 11, 1731 became February 22, 1732.

Financial statement ratios

March 13, 2018

Ratios are tools used to evaluate a company’s financial statements. Here are some of the more commonly used ratios.

Working capital ratio
Current assets ÷ current liabilities.
Illustration: Current assets of $2,500,000 ÷ current liabilities of $1,250,000 = 2.
This is also called the current ratio. Its purpose is to determine how the business can handle its daily operations. A number greater than one is good, with the greater the number the better. Less than one indicates an “insolvent” company and one that needs to be watched closely. The current assets include assets likely to be converted into cash within the next year while current liabilities are due to be paid within the next year.

Debt to equity
Total debt ÷ stockholders’ equity or capital.
I prefer the long term debt to equity ratio. See next ratio.

Long term debt to equity
Long term debt ÷ stockholders’ equity.
Illustration: LTD of $9,000,000 ÷ S/H equity of $6,000,000 = 1.5.
The purpose is to determine how leveraged the company is. The greater the long term debt in relation to equity, the more leveraged the company is, the more sensitive to interest rate increases it is, and the more sensitive it is to situations that could cause a temporary or permanent inability to make principal payments timely. Long term debt holders usually have covenants that place restrictions on the company causing adherence to certain controls or measures that are triggered when they are violated. Long term debt includes all debt except the current liabilities. If perchance the current liabilities exceed the current assets, this will be evident in the working capital ratio. A similar ratio is total debt to equity which I do not think is as effective of a measure since the total debt includes current liabilities with no offset for current assets and this makes the ratio harder to use as a tool. I previously posted a blog explaining leverage on Nov 11, 2014. [Included below]

Receivables turnover or days to collect
365 ÷ (Net sales revenue ÷ average net receivables).
Illustration: 365 ÷($12,000,000 ÷3,000,000) = 91 days.
Note: To determine average net receivables divide the beginning and ending receivables by 2.
This indicates how many days sales are tied up in receivables giving an indication about how fast sales are converted into cash. The longer the period, the greater the possibility that cash will be tight necessitating a slowdown of vendor payments or the need for additional capital or borrowing.

Return on assets
Net profit ÷ average of total assets.
Illustration: $1,000,000 profit ÷$12,000,000 average total assets = 8.33%.
This indicates how well the company is doing utilizing its assets. I think a better ratio is return on equity. The reason I do not use this is that the company could have recently borrowed $5,000,000 and it could be invested in short term marketable securities until utilized. This would increase its total assets by that $5,000,000 distorting the return on assets percentage.

Return on equity
Net profit ÷ average stockholders’ equity.
Illustration: $1,000,000 profit ÷ $2,500,000 S/H equity = 40%.
This appears to be a better measure of resource utilization. A further ratio could be return on market value or market cap. This is more appropriate for a public company with a readily ascertainable market value. If this is applied to a private company using a market cap formula for its valuation it can provide interesting insights. For instance , a private company earning $1,000,000 applying a 15% market cap percentage or return on investment percentage can indicate a company value of $6,700,000. Another way of looking at this is where there is an industry standard such as a percentage or multiple sales is to use that value as the denominator instead of S/H equity. Still another way would be to adjust S/H by the unstated values of certain assets the company has. Note that for a public company, the return on market cap is 1 ÷ the P/E ratio. For instance if the P/E is 20 the return on market value is 5%. There are other variations on this ratio especially where there is considerable debt and high interest expenses, but that is not for now where the purpose is to provide basic ratios.

Return on sales or net profit margin
Net profit ÷ net sales.
Ill.: $1,000,000 ÷$12,000,000 = 8.33%.
This shows how much ends up on bottom line. A note about using these ratios. When working with public companies they usually work. With private companies additional thought needs to be applied. For instance is the net profit before or after income taxes? If the entity is an S corporation, partnership or LLC it would not pay income taxes but the owners would be paying it personally on their individual tax returns. Also, the controlling owners could be taking higher than normal compensation or excessive fringe benefits making comparisons with other companies not feasible. It could also make comparisons between years of the same company inappropriate since these amounts could vary greatly from one year to the next.

Earnings before interest and taxes or EBIT
Net profit + interest + taxes added back.
This is a method to normalize earnings and make operational comparisons more consistent by adding back interest and taxes. Interest is a function of borrowing which is usually necessitated by a shortage of capital. A fully capitalized company would not have to borrow for capital purpose and make interest payments; or if it did borrow it would be to level out short term cash flow needs, or possibly to fund equipment or real estate. Adding back interest eliminates this bias. As said earlier, some entities do not pay tax and some could pay significantly different state and local taxes depending upon their location. This is another normalization feature.

EBITDA (Earnings before interest, taxes, depreciation and amortization)
Net profit + interest + taxes + depreciation + amortization.
This is a variation on EBIT that I do not use and feel is greatly misused because while it adds back the depreciation and amortization that was deducted to arrive at net income, it takes no account of normal recurring fixed asset additions which are usual for companies with equipment. This is an example of something that is used that is not understood but where the user feels it makes them a “player” or places them in a “knowledgeable” position. Bull duty! I posted a blog on this on Nov 13, 2014. [Included below]

Gross profit margin
1 – (Cost of sales ÷ net sales).
Illustration: 1- ($8,000,000 cost of sales ÷ $12,000,000 sales) = 33.3%.
This indicates the percentage of each sale that is left over after subtracting the direct costs of what was sold. The greater the margin the better. Companies with high margins have greater dollars available from sales to be used for overhead and fixed and operating expenses and available profits.

Inventory turnover
365 ÷ (Cost of sales ÷ average inventory).
Illustration: 365 ÷($8,000,000 ÷1,600,000) = 73 days.
This shows that the average inventory is 73 days of sales. A higher number indicates inventory being held for longer periods while a lower number shows a faster turnover. The longer the inventory is held, the greater the risk of not selling it and of inventory becoming stale, obsolete or damaged.

There are myriad others, but these are some of the more popular ratios. Ratios can be categorized into types such as for liquidity, performance, and capital structure, but there are not that many shown here and I did not think it mattered here to categorize them. The purpose of ratios is to provide a quick look at certain big picture or essential items. All ratios are better used when they can be compared with previous periods to determine trends. The more periods the better able to detect developing trends. For more serious analysis I prefer to have as many as five periods for comparison. In many cases it is not as much the ratio that matters as the change and trend.

Letting go

March 8, 2018

A problem I see with many entrepreneurs is that they are control freaks and do not want to let go. They are all brilliant and creative and some have an obsessive drive to succeed; yet many are just not good as managers and the lucky ones realize this before it is too late.

Even if they were great managers, I believe their talents would be better served by hiring people to do what can be delegated. I also know that a business centered primarily on one key person has less value than one with a cadre of managers in strategic positions. Also, being “too busy” is worn by many as a badge of pride when it really is a mechanism that dissipates energies and causes an early burnout for him or herself and the business.

A business becomes a body separate from its founders and owners. Businesses have a responsibility to all of its stakeholders and there is no room at the top for people that serve to retard its development and growth. Nevertheless, I want to discuss why it is in the owner’s interest to let go.

Being driven is not bad, but driving yourself to the exclusion of everything else, is. You cannot and should not disregard your spouse and children, a partner or close friends, a pet, an apartment or house that needs to be taken care of, a long ago favored hobby or sports activity, entertainment at a sporting event, show or movie, an occasional day goofing off, or even a real vacation without the smartphone. Your body needs this and so does your mind. Hopefully the gym or workout has not been abandoned.

One way to manage yourself is to manage your time better. For starters, treat your time like a valuable commodity and look at your ROI – the return or value you get for your input on what you spend time on. We would all agree that investing your money for a 1% return is not the way to go. Well, spending your time on a function that provides minuscule benefit, or a benefit substantially less than you could otherwise get doesn’t make sense either. You should pass on it. How about setting up your day with high payback functions leaving the lesser yielding or dividend paying tasks to others. Even if they totally screwed it up, it probably would not make a difference in the big picture. In doing this, you need to draw a line marking a division between the higher and lower payback tasks and not go below that line. And if perchance nothing below the line got done, what difference would it make in your life and for the business?

We always have time for funerals or to get really sick. Why not take time to better spend your time so you could enjoy your life and manage and grow your business better and extend your warranty period? It is a good investment.

I posted a previous blogs on this topic. They can be accessed in the archives. The dates are April 28, 2015, October 30, 2014, October 17, 2013, October 15, 2013, February 21, 2013 and April 2, 2015.

Roger Bannister

March 6, 2018

Sir Roger Bannister just passed away at age 88. He was the first person to break the 4 minute mile running the mile in 3 minutes and 59.4 seconds. .5 of a second gave him sports immortality. Actually, I remember when he broke the 4 minute mile. I was hanging out with some friends when someone came over and told us about it. Soon afterwards the floodgates opened and many others also beat the 4 minute mile.

Last Tuesday I wrote about Lindsey Vonn losing the downhill by about a half second. 3:59.4 is half of a second below that 4 minute magic number. A blink takes longer. In his autobiography Bannister tells how every detail mattered and made a difference. That is what last week’s blog was about – the small details that make big differences.

For some reason the 4 minute mile was a barrier that couldn’t be overcome…until it was. Once overcome, there was a new barrier and the old one no longer created the fence for which people could not surmount. Human nature and in particular business is a lot like that. Many tend to avoid new things, new challenges, new tests, or any type of change preferring the comfort of the familiar.

The really successful people do not see barriers, only opportunities. They do not let others create blockades for them but look to see how they can create new ground and possibly the walls for those behind them. They are egocentric in a productive way blocking out the noise created by the naysayers and spectators. They look beyond what is and toward the benefits that can be. They need thick skin and an arrogance and obsession to succeed and need to summarily shove aside the criticism from people that are afraid or missteps or of treading outside their comfort zones.

Be a trail blazer. Don’t let the barriers stop your quests. Be like a Roger Bannister!

Michael Crichton again

March 1, 2018

I wrote about Michael Crichton in a June 28, 2012 blog and am reiterating that I continue to learn from him.

I just finished “Dragon Teeth” and found out that the amazing Brontosaurus and many of its genus lived here in the Mid-Western states. Who would have ever thought this? I guess I should have known this since I’ve seen their skeletons and recreated drawings many times at the Museum of Natural History in New York and museums elsewhere, but I never read the fine print on the description cards choosing to spend my time marveling at their mammoth size and the many varieties of dinosaurs.

While Crichton died in 2008, the outline, notes and manuscript for this book was discovered by his wife and became this book. Dinosaurs did roam the American West and the two paleontologists that were major figures in the fiction novel were described realistically along with their discoveries; although many of the details of their exploits, rivalry, antagonism and altercations were exaggerated [slightly] and condensed into the story that takes place over a few Summer months. The other figures including the central character is fiction, although some real figures appear or are mentioned peripherally such as Wyatt Earp, Wild Bill Hickock, Robert Louis Stevenson and General Custer. My wife and I were in Deadwood and the author describes it as it was, and still is.

The book points out that evolution was a newly “discovered” scientific theory just a couple of years prior to the start of the Civil War and at the time of the novel, 1876, the year of our Centennial Celebration, it was hotly debated and denied by many. The first dinosaur to be described in a scientific manner was in 1824, although Thomas Jefferson earlier wrote some remarks about fossils possibly representing extinct creatures but he kept that private since such thoughts in the early 19th Century were considered heresy. In today’s age with instant worldwide access to information I found the time line suggested in “Dragon Teeth” very interesting and eye opening since much of this lack of knowledge existed less than 150 years ago. A pithy quote from one of the two central paleontologists is “I am thirty-six years old, but at the time I was born dinosaurs were unknown. All the generations of mankind has been born and died, lived and inhabited the earth, and none ever suspected that long, long before them, life on our planet was dominated by a race of gigantic reptilian creatures who held sway for millions upon millions of years.” Amazing!

I found parts of the story tedious and some of the characters shallow, but that did not deter me from wanting to keep on reading and turning the pages to find out what was coming next. This is a quick, enjoyable and enlightening read. Read this book!

Lindsey Vonn

February 27, 2018

The Olympics was fantastic and so was Lindsey Vonn. She is a proud American champion; you don’t need a gold medal to validate that. She has her medals, but last week, at age 33, she became the oldest woman’s Alpine skiing medalist in Olympics history. She is also just the third American to capture three Olympic Alpine skiing medals.

Vonn’s speed was 1:39.69 minutes. The gold medalist was 1:39.22 and silver medalist was 1:39.31. Lindsey missed the gold medal by less than a half second! She skied for 99 seconds at a speed over 70 miles per hour on a 1.7 mile slope and was a half second short! There were many other tournaments that were settled by even narrower margins. This tells me that everything counts and we must pay attention to the slightest details. In business, half seconds don’t usually matter, but details do. A slight nod in a negotiation, a split second loss of a smile when training a beginner, a single letter missing from a client’s name or number from their address, or an expensive expertly tailored suit with scuffed shoes can affect a major business deal or relationship.

Lindsey said that “the last eight years have been full of ups and downs. A lot of downs. But it’s all made me who I am – a stronger person. It make me appreciate every opportunity I’ve have. I’m thankful to be here on the podium in most likely my last downhill race.” After the race, Sofia Goggia, the gold medalist said of Lindsey “She is the greatest.”

Lindsey is a Champ. This was her last Olympics but I have a feeling we will be seeing a lot more of her. She will not be fading into the woodwork. Good job Lindsey, we are proud of you and Good Luck!

Further, everyone participating in the Olympics, whether they medaled or not, and their support staff, should get our accolades – they are all champions and served the United States proudly in the Olympics. Congratulations and Thank You!

A great big Kamsahamnida to Pyeongchang for hosting a wonderful Olympics where, for two weeks, peace and calm reigned in the World.