Chapter 17: Accounting and Econ

In this Excel tutorial I'm going to be talking to you about how accounting and Engineering economy come together. In accounting you have basically two different statements. You have an income statement, which are things we've been talking about this entire time and a cash flow statement. So let's just start with an income statement. Income statement basically covers revenues, expenses, and taxes. So remember in year 0 you don't have any Revenue so there shouldn't be a value there. But you start earning Revenue in Year 1 and in this process we're going to go for five years. Typical expenses are like labor, material, overhead. Depreciation counts as an expense and then you might have some interest that you pay on a debt. So these are typical expenses.

Taxable income simply equals revenues minus expenses, which is how I have it coded here. Then we take the taxable income times our tax rate of 40% and then to get net income and simply taxable income minus income taxes to get net income. I've done this for each of the 5 years. Now in a cash flow statement, now we're going to talk about how your money is moving around. Typical categories are operating investment and financing. In your operating activities your net income has to come back over again and so does your depreciation. So I've simply pointed to where my net income was in E13 and I've done the same thing here. And you can see that I've done that on depreciation.

The thing about depreciation is it is used for tax purposes but is not an actual cash flow. That's why it has to go back in here. Say you invested $150,000 in this activity remember in year 0 you don't have any Revenue you should only have that investment. And say you had $50,000 you got back and Salvage. Financing activities, you borrowed $50,000 to get going, you repay principal every year. And what you will get in the end is a net cash flow. So we have a negative $100,000 all told. Negative 150 plus the 50 and then here it is simply our net income plus our depreciation, plus our principal repayment to get our values here. Now, that's accounting but Here Comes engineering economy.

This right here represents a net cash flow. That's what we've been working on this entire time. So now you can do any of the plethora of analysis that we've covered. You can do Net Present Value, you can do annual, you can do IRR, on that net cash flow. If you want to do Net Present Value simply equals NPV, my rate is 8%, my cash flow, remember, I only want through 1 year, 1 through 5 because the $100,000 is already sitting at year 0 and then I will add that in because it's already sitting at year 0. And you get just a little over $95,000 . Remember we've been talking about we have a positive cash flow there it makes it look like, hay! It might be a good project for us.

If you want annual that's equals payment, my rate is 8%. Yes, I'm hard coding the 5 which is not something you would normally want to do. And our present value is the negative NPV that we just calculated and you can see that annually, you're making almost 24,000 dollars. That might be good for you depending on what your criteria are to determine a good project. And for IRR it’s simply IRR, highlight your net cash flow, and you're done. You have an internal rate of return of 35% which gives you something to compare to your MAR. So in this Excel tutorial, I've shown you how engineering economy and accounting come together to do an analysis of a project.