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The McGraw-Hill 36-Hour Course: Finance for Nonfinancial Managers
By H. George Shoffner, Susan Shelly, Robert A. Cooke
The McGraw-Hill Companies, Inc.Copyright © 2011Rupert Scofield
All rights reserved.
NUMBERS, NUMBERS, NUMBERS: THE WHY AND THE HOW
STATISTICS AND NUMBERS THAT CONFOUND US
My attitude toward numbers was strongly influenced by having Miss Ball for Algebra in the 10th grade. She was most successful—in turning off any interest I had in numbers! Her stated philosophy was: "Don't try to understand why. Just do it!" Most of us have run into such a figure at some time in our youth. If we ever thought that there wasn't much fun in numbers, Miss Ball made sure we forever believed it. To be fair, there were other, kinder teachers who explained reasons and tried to tie mathematics to popular applications. But they were hampered by being required to use textbooks that asked questions such as:
Mary had twice as many apples in her basket as John had chickens in a number of boxes, and the number of boxes was the square root of Alice's age. Alice was twice as old as Mary and half of John's age. How many wings did the chickens have and should they be fried or broiled?
Who cares? This attitude carries over to our adult lives. We hear statistics about the gross national product, the unemployment rate, stock prices, averages, the national debt, and our employer's productivity gains. We know that all of these things are important, but the basketball game or the latest movie on HBO is usually more appealing.
SCORES: NUMBERS WE ENJOY
Yes, these experiences made most of us averse to numbers, particularly when they appear formally on tax returns, financial reports, bank statements, and so forth. But note that we still find numbers to be friendly in informal areas such as the point spread in the Super Bowl, a golf handicap, or a tennis score. Those of us who have been to Las Vegas or Atlantic City know all the combinations of numbers that add up to 21, although we would rather we had never become acquainted with the combinations that add up to 22 or more.
Years after my experience with Miss Ball, I became comfortable with numbers and spent much of my time involved with them. How? I took the easy step from sports and other leisure activities to business. I say it's an easy step, for business has been described as "sports, but for real." Business is competitive. If you commit a foul, the judge will penalize you, and score is kept in dollars. So, if you need or want to be more comfortable with financial reports and the like, think of them as scorecards. If your company, division, or other area of responsibility has made more profit or reduced expenses, you have won. The prize is more income, a promotion, or both. For example:
You manage a restaurant for the G-Spoon Eatery chain. Compared to last year, sales have increased by $500,000. Net profit has increased by $100,000, and net income as a percentage of sales is 17 percent, compared to 5 percent last year. It sounds good, but it's still a bunch of numbers—pretty dry stuff. However, if you make some more computations, you find that, because of the increase in sales and profits, your bonus will be $50,000. Now the numbers become much more interesting. And if you want to equate that $50,000 to being able to turn in your old Chevrolet for a Porsche, the numbers become extremely interesting.
So, as you read on in this chapter, think of the numbers as a scorecard. Just as a tennis book will explain the intricacies of tennis scorekeeping, this and the following chapters will explain the intricacies of business scorekeeping. Or think of it this way: Most of us like to talk (remember all those bull sessions as a teenager?); in other words, we are social animals who like to communicate with each other. When we communicate about boyfriends, girlfriends, spouses, war, peace, or Uncle Lem, words are the language of communication. When we communicate about business, we use numbers as well as words, for financial numbers are the basic language of business. So, when you study financial numbers, you are merely adding to your vocabulary.
SIMPLICITY MAKES IT EASIER
In most of the examples and case studies in this book, you will find numbers rounded to the nearest hundreds or thousands of dollars because that makes it easier to understand the concepts. You can do the same with your own numbers. If you are dealing in millions of dollars, round off the numbers you are working with to the nearest thousand. If you are dealing in thousands, round off to the nearest hundred, and so on. Of course, pennies should almost always be disregarded (unless you are dealing with costs per each item, as discussed in the next paragraph). After all, if sales are actually $8,573,425.76, and you round it off to $8,573,000 you have introduced an error of only 0.005 of 1 percent—hardly enough to alter any decisions made based upon the report.
Accountants call this concept materiality. A material error is one which is large enough to cause people to make a decision that is different from a decision they would make if they had the correct figures.
For instance, let's say you are the president of the Pointless Pencil Company. Your accounting department has a clerk who, after rounding off too many numbers and making several errors, computes that each pencil costs $0.01 to manufacture. You and your chief accountant decide, therefore, that you can sell the pencils, in jobber lots, at $0.013 each. You do so, and after several months find that the company checkbook has a zero balance and many bills remain unpaid. Your accountant reviews the clerk's figures and finds that he rounded the cost from the actual figure of $0.014 per pencil to $0.01. Of course, had you known that the pencils really cost you $0.014, you would not have run the company into bankruptcy by selling them for only $0.013 each. The error the clerk made was a whopping 29 percent ($0.004 ÷ $0.014) and was obviously material, for it caused an incorrect decision. The moral: Round off whenever it will not be material (as the 0.005 percent error in the first example), but be careful. Sometimes even a fraction of a penny can be material.
GOING INTO BUSINESS (OUR NOVEL)
Business schools use the case study method of instruction. Why should we be different? What follows is a story of a company that starts in simple fashion as a retailer. The evolution of this company will serve to illustrate many basic concepts. In later chapters, the company expands into service, contracting, and manufacturing, so nearly all types of businesses are illustrated.
You did know that accountants are frustrated novelists, didn't you? That is why, woven through the figures in this book, you will find the story of Rosie Rouse and how she started and ran the Spouse House Company. What's a Spouse House? Until recent times, disgraced or out-of-favor spouses were banished to the doghouse in the backyard. Poor Rover, displaced from his home, had to do the best he could under the porch or in the bushes. Now, with the emerging support for animal rights, Rover can no longer be evicted from his doghouse. The disgraced spouse must find shelter elsewhere. Here is a new need, a new market—shelter for discredited spouses.
Rosie is the first to see this new market, and the first to fill it. She decides to sell Spouse Houses—buildings that are much larger than doghouses but small enough to fit in backyards. These buildings include amenities such as recliner, carpet, and insulation. She starts the business by making arrangements with Fred's Sheds, a manufacturer of Dutch colonial garden storage sheds. To fill Rosie's orders, Fred will modify sheds into Spouse Houses by adding the amenities.
Rosie rents a small office, has a telephone installed, and places some advertising in the newspaper.
Excerpted from The McGraw-Hill 36-Hour Course: Finance for Nonfinancial Managers by H. George Shoffner. Copyright © 2011 by Rupert Scofield. Excerpted by permission of The McGraw-Hill Companies, Inc..
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