The Manager’s Pocket Calculator This page intentionally left blank The Manager’s Pocket Calculator A Quick Guide to Essential Business Formulas and Ratios Michael C. Thomsett American Management Association New York • Atlanta • Brussels • Chicago • Mexico City • San Francisco Shanghai • Tokyo • Toronto • Washington, D.C. Bulkdiscountsavailable.Fordetailsvisit: www.amacombooks.org/go/specialsales Orcontactspecialsales: Phone:800-250-5308 Email:[email protected] ViewalltheAMACOMtitlesat:www.amacombooks.org Thispublicationisdesignedtoprovideaccurateandauthoritative informationinregardtothesubjectmattercovered.Itissoldwiththe understandingthatthepublisherisnotengagedinrenderinglegal, accounting,orotherprofessionalservice.Iflegaladviceorotherexpert assistanceisrequired,theservicesofacompetentprofessionalperson shouldbesought. LibraryofCongressCataloging-in-PublicationData Thomsett,MichaelC. Manager’spocketcalculator:aquickguidetoessentialbusinessformulasandratios/ MichaelC.Thomsett. p. cm. Includesbibliographicalreferencesandindex. ISBN-13:978-0-8144-1635-8 ISBN-10:0-8144-1635-7 1.Businessmathematics. I.Title. HF5691.T4832011 650.01(cid:2)513—dc22 2010003411 (cid:2)2010MichaelC.Thomsett. Allrightsreserved. PrintedintheUnitedStatesofAmerica. 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Printingnumber 10 9 8 7 6 5 4 3 2 1 Contents INTRODUCTION: TheBasicProblemwithNumbers ix CHAPTER 1: CompoundInterest:ThePowerof Money 1 TimeValueof Money:TheConcept 2 AccumulatedValueofaSeriesofDeposits 19 LookingAhead 22 CHAPTER 2: PresentValue andSinkingFunds 23 Present ValueofaSingleDeposit 24 Sinking FundPaymentsandPresent ValueperPeriod 27 LoanAmortization 31 Reading LoanAmortizationTables 38 Annual PercentageRate 44 LookingAhead 45 CHAPTER 3: Ratesof Return 46 Return onRevenueand Equity 46 CashReturn andCashFlow 53 Returns onPurchasesandSales 58 Investment-BasedReturns 61 AnnualizedReturn 65 LookingAhead 67 CHAPTER 4: CalculatingBreakevenandAfter-Tax Profit 68 HiddenCosts 68 TheInflation Effect 73 Taxesinthe ProfitabilityEquation 76 BreakevenCalculations:Inflation andTaxes 79 v vi Contents CalculatingCashFlow 83 LookingAhead 86 CHAPTER 5: FinancialReportingFormulas:TheBalanceSheet 87 BalanceSheet Basics 87 WorkingCapitalRatios 91 RatiosShowing ManagementofWorkingCapital 94 CapitalizationRatios 99 CombinedRatios 105 LookingAhead 108 CHAPTER 6: FinancialReportingFormulas:TheIncomeStatement 109 IncomeStatementBasics 111 DollarandPercentageReporting 115 Costof GoodsSoldRelationships 121 Revenueand ProfitabilityTrends 125 CoreEarnings 127 LookingAhead 128 CHAPTER 7: DepreciationCalculations 130 BasicDepreciationRules 131 Straight-Lineand DecliningBalanceDepreciation 132 ClassLivesandRecovery Periods 136 DepreciationCalculationsfor RealEstate 140 HomeOfficeDepreciation 145 Amortization 147 LookingAhead 149 CHAPTER 8: BringingReportsto Life:PowerfulArguments withthe Numbers 150 PickingYourReport Format 151 NarrativeSections 153 FinancialSections 158 CombiningNarrativeandFinancialContent 161 GraphicsinReports 164 LookingAhead 166 Contents vii CHAPTER 9: BudgetingCalculations:AssumptionsandProrations 168 DocumentingYourAssumptions 169 Addressing theExpense Issues 172 ProratingExpenseEstimates 175 CalculatingVariances 177 RevisingBudgets 180 TheNature ofRevenueForecasts 182 LookingAhead 185 CHAPTER 10: Statisticsfor EffectiveReporting 186 ManagementApplication ofStatistics 186 Statistical Averages 190 Dispersion, Variance,andDeviation 196 Accuracy inStatistics 202 LookingAhead 206 CHAPTER 11: IncredibleMathShortcuts 207 AdditionShortcuts 207 SubtractionShortcuts 211 LogicalRules 214 MultiplicationShortcuts 216 Division Shortcuts 225 LookingAhead 226 CHAPTER 12: IncredibleConversion,Measurement,and TimeShortcuts 227 Conversion 227 Measurements 236 TimeShortcuts 241 APPENDIX: SummaryofFormulas 245 INDEX 269 This page intentionally left blank I N T R O D U C T I O N The Basic Problem with Numbers I t’s all in the numbers. Everyone has heard this statement and it is true. Your performance is invariably judged by how much profit you create or by how much cost you incur in your segment, team, or department. The so-called bottom line—profit or loss—is the universal meansformonitoringperformanceand fordeterminingwhetheranini- tiativewasworthwhile. With the dominance of the bottom line in every aspect of how your performance is graded, you have a distinct advantage if you are skilled atconveyinginformationintermsofprofitability.Conversely,youareat a distinct disadvantage if you cannot communicate the profit or loss aspects of your work to management. On a most basic level, just asking management for something is less effective than demonstrating how an approvalisgoingtocreateadditionalprofitsorcutcosts(relateddirectly to revenues) and expenses (overhead, not related directly to revenues). Thisistherudimentarydistinctionbetweenmanagerswithcommunica- tion skills and those who struggle every day trying to find the best way tocommunicatewhat theyknowandwhattheyhaveachieved. ix