Applied Analytics in an Organizational Context
Module 3
Applied Analytics Program
September 22, 2023
Office Hours:
Prof Vannan: On Zoom. Tuesdays, Thursdays 10AM – 11AM
Join:
URL: https://columbiauniversity.zoom.us/j/97844046797?pwd=SytlaDgxR09GbXM1VHN5WUVBOVZpZz
09
Meeting ID: 978 4404 6797
Passcode: 203709
Akshaya Vardhan: By appointment - arv2128@columbia.edu
Agenda
Accounting overview
Balance Sheet
Income Statement
Learning Objectives
Describe key components of financial statements
Explain the key financial metrics that drive the business
Create a financial statement from provided operational information
From last week – Start with the problem
https://www.youtube.com/watch?v=vVJ4FZsDTpg
Automation and Decisions
Data Insights Action Results
Where might automation impact the gap?
What is the nature of the gap?
Is it valid to argue that a good decision leads to a good result?
• Data and analytics enables decisions that are based on rational evidence, rather than experience.
• In a rapidly changing environment, the value of experience is limited. Therefore, embedding analytics in the business
will drive better business results.
• Is this argument deductive or inductive?
Finance as a “Lens”
Financial Accounting:
• Standard financial metrics are used to communication
with external stakeholders
• Governed by law and principles – GAAP/IFRS
GAAP – Generally Acceptable Accounting Principles
IFRS - International Financial Reporting Standards
Finance as a “Lens”
Managerial Accounting:
• Information used within the company so that its
management can operate the company more effectively
Financial and Managerial Accounting
Financial Statements
Balance Sheet – Describes assets controlled by the business
and how those assets are financed
• Assets = Liabilities + Owners Equity
Income Statement (P&L) – Describes achievement of revenue,
and resourse expended to produce that achievement
• Income = Revenues - Expenses
Uses of Financial Statements
Managers –
Assess performance and identify areas requiring intervention
Shareholders –
Understand how capital is being managed
Outside investors –
Identify opportunities
Lenders and suppliers –
Assess credit worthiness
Balance Sheet
Representation of the company’s:
• Financial health - company’s ability to meet its obligations over
the long term
• Liquidity – company’s ability to meet current obligations
Measures operating performance
Produced periodically – quarterly and annually
Why is understanding financial health important for both
for-profit and non-profit organizations?
Components of Balance Sheet
Assets - What the company owns
• Listed in order of liquidity - ease with which they can be converted to cash
• Presented at the lower of the purchase price or market value at the time of the
financial statement
• Tangible assets are depreciated over their useful life
Liabilities
• Amounts that the company owes to others for products and services it has
purchased and amounts that it has borrowed
Assets – Liabilities = Equity
Balance Sheet
Assets
Liabilities
Shareholder Equity
Assets
Why are two years
shown?
Dollar amount of services provided or products
delivered that have not yet been paid for by
customer
Funds in checking accounts in commercial
banks, and securities with very short
maturities (90-120 day maturity)
Intangible assets, e.g. brands
All non-current assets that are aggregated
because they are too small to list separately.
Investment made in the manufacture,
production or purchase of products
Amount paid, at time of purchase, for the fixed
assets that the company owns (or lower) minus
depreciation
Liq
ui
di
ty
Inventory
Financial investment that the company has made in the manufacture, production, or
purchase (retail store) of products that will be sold to customers
• Finished goods - completed products ready for
shipment to customers. Reported value includes
costs directly associated with completing the
product
• Work in process - value has been added by the
company but it is not yet ready to be delivered to
the customer
• Raw materials - products or components that
have been received from vendors or suppliers to
which the company has done nothing
Investments and Intangible Assets
Ownership of other companies
Partial equity stakes in other companies, including joint ventures
Patents, Trademarks, Copyrights
Goodwill - Value of acquisition(s) above the value of the assets on
the balance sheet
Reported at the lower of cost or market
Fixed Assets
Tangible assets owned by the company and used in the operation
of its business that are expected to last more than one year
• Land
• Buildings
• Machinery and Equipment
• Vehicles
Gross book value - original amount paid for the tangible assets that
the company currently owns, subject to the lower of cost or market
accounting rule
Depreciation
Tangible assets are depreciated over their useful life
Straight-line depreciation - most common method of depreciation
• Gross book value (cost base of asset) divided by the number of years in the
useful life of the asset
Net book value – Gross book value minus depreciation
What is the reported net book value of an asset that is fully depreciated?
Total Liabilities - Sum of Current Liabilities (Must be paid within
1 yr) and Long-term Debt (Payment longer than 1 yr)
Liabilities
Amount borrowed from bank or other lender,
and not yet repaid
Amounts owed to vendors or suppliers for
products delivered and services provided for
which payment has not yet been made
Liabilities that had a maturity of more than
one year when the funds were originally
borrowed, but are now due in less than one
year
Expenses and Expenditures
Expenditure - disbursement of cash or a commitment to disburse cash (Costs that
maximize long-term value of business)
• EX: Capital investment - recognized over a period of operation
Expense - recognition of the expenditure and its recording (income statement) for
accounting purposes in the time period(s) that benefited from it (costs that need to
be incurred for the business to operate)
• Matching principle (GAAP)- Expenses should be recorded in the period of time
that benefited from the expenditure rather than the period of time in which
the expenditure occurred.
• Accrued expenses – outstanding charges at date of reporting. Total expense
reported on income statement, but liability for outstanding debt reported on
balance sheet.
Balance Sheet
Balance
Income Statement
Measures the company’s achievement (revenue) and the resources
(expenses) that were expended to produce that achievement
Describes the performance of the company over a period of time,
usually a month or a year
• Also called a statement of operations or a profit and loss
statement (P&L)
Revenue - Expenses = Profit or Net Income
Income Statement
Dollar amount of products and services
provided to customers during the year.
Recorded when the customer received and
approved products or services purchased
(Earnings before Interest, Taxes,
Depreciation and Amortization
EBIDTA = Gross Profit – SG&A)
Cost of producing or purchasing the
goods that are delivered to customers
Cost of operating the company
Portion of capital expenditure allocated
to current year.
Profit after costs of operating the company
Revenue minus all operating and
non-operating costs
Cost of Goods Sold
Cost of producing or purchasing the goods that are delivered to customers
Includes:
• Raw materials
• Purchased components
• Direct labor
• Operating and repairing the equipment used to manufacture the product
• Other manufacturing expenses, including utilities and maintenance of the
production facility
Gross Margin Across Industries
Industry Gross Profit Margin
Auto Repair & Maintenance 21%
Construction 19%
Hotels & Hospitality 76%
Maintenance Services 30%
Restaurants 67%
Retail 22%
Tax Services 90%
Transportation 47%
Why are the gross margins of Tax Services and Construction so different?
https://www.caminofinancial.com/profit-margin-by-industry/
General and Administrative Expenses
Cost of operating the company - not associated directly with producing the
product
Includes:
• Staff expenses (accounting, computer operations, senior management)
• Selling expenses (salaries, travel)
• Promotional expenses (advertising, trade shows)
• Research and development (technological research)
Net Margin
21% - “Tax Cuts and Jobs Act”
2022 Net Margin = $17,105/$157,403 = 10.9%
Amount of profit that the corporation
has achieved during the year
Net Margin = Net Earnings/Revenue
Did the profitability of Home Depot increase from 2020 to
2022?
Breakout discussion
15 minutes to compare Home Depot and Lowes based on what we
have learned
• What is the big difference in current assets? Why is there a
difference?
• Which company is operating more efficiently?
• What is the net margin of both companies?
Compare Home Depot and Lowe’s
What is the big difference in current assets?
Why is there a difference?
Compare Home Depot and Lowe’s
Which company is operating more efficiently?
What was Lowe’s net margin in FY2022?
Compare Home Depot and Lowe’s
FY 2022 Home Depot Lowes Home Depot/Lowe's
Sales 157,403 97,059 1.62
Cost of sales 104,625 64,802 1.61
Gross Profit 52,778 32,257 1.64
Gross Margin 33.5% 33.2%
SG&A 26,284 20,332 1.29
SG&A/Sales 16.7% 20.9%
Depreciation 2,455 1,766 1.39
Operating Income 24,039 10,159 2.37
Operating Margin 15.3% 10.5%
Interest 1,617 1123 1.44
Net Earnings 17,105 6,437 2.66
Net Margin 10.9% 6.6%
Net Margins across industry sectors
Comparison of parts of the healthcare sector
Margins Across Industries
Industry Net Profit Margin Gross Profit Margin
Auto Repair & Maintenance 12% 21%
Construction 5% 19%
Hotels & Hospitality 8% 76%
Maintenance Services 10% 30%
Restaurants 15% 67%
Retail 5% 22%
Tax Services 20% 90%
Transportation 19% 47%
What can you infer about the cost structures of these industries?
Do Financial Statements Communicate the
Value of Digital Companies?
GAAP - Assets reported on a balance sheet have to be physical in nature, have to be owned by
the company, and be within the company’s confines.
• Digital companies often have assets that are intangible in nature, and many have ecosystems that
extend beyond the company’s boundaries.
• Many digital companies have no physical products and have no inventory to report.
• Investments in its building blocks of value (e.g., peer and supplier networks, customer and social
relationships, computerized data and software, and human capital) are not capitalized as assets; they
are treated as expenses in calculation of profits. So the more a digital company invests in building its
future, the higher its reported losses.
• In contrast to physical assets that depreciate with use, intangible assets might enhance with use
because of the network effect, which implies negative depreciation expense. Fundamental idea
behind the success of digital companies (the increasing returns to scale) goes against a basic tenet of
financial accounting (assets depreciate with use)
https://hbr.org/2018/02/why-financial-statements-dont-work-for-digital-companies
Intangible Assets and Investments
https://www.morganstanley.com/im/publication/insights/articles/articles_onejob.pdf
Intangible Assets
Apple, Google, Microsoft, Amazon and Tencent
2019:
Book value - $172 billion
Market value - $3.5 trillion
Tangible assets ~5% of market value
https://www.oceantomo.com/intangible-asset-market-value-study/
https://www.advisorperspectives.com/commentaries/2018/03/15/why-financial-statements-dont-work-for-highly-innovative-companies
“Several weeks ago three professors
from the Columbia and Dartmouth
business schools recapped some of
their work on accounting for
intangible investment in a Harvard
Business Review article. Their key
finding, which builds on Professor
Baruch Lev’s analysis in The End of
Accounting, is that, “accounting
earnings are practically irrelevant
for digital companies”.”
“earnings explains only 2.4% of
variation in stock returns for a 21st
century company — which means
that almost 98% of the variation in
companies’ annual stock returns are
not explained by their annual
earnings“.
Top R&D spenders - FY 2020
Amazon
• Does not report R&D as a separate line item; expenditure of $42.74 billion (11.1% of net
sales) on “technology and content”
Alphabet
• $27.57 billion on R&D (15.1% of revenue)
Huawei
• ¥141.893 billion on R&D (15.9% of revenue)
Apple
• $18.75 billion on R&D (7% of net sales)
https://www.nasdaq.com/articles/which-companies-spend-the-most-in-research-and-development-rd-2021-06-21
Assignment 1
Due by 11:59PM (EDT) on October 12
In this assignment you will evaluate options for developing a new SaaS product
based on financial and strategic considerations. Your organization has three
options:
• Build a technology product in-house
• Collaborate with a startup
• Do nothing
You are tasked with developing a recommendation for your CEO
Next Class
Managerial Accounting
• Budgeting, planning, analysis
• Financial projections and analysis
• Finance as a tool for decision-making
Required readings:
Fields, E. (2002). Essentials of Finance and Accounting for Nonfinancial Managers.
– Chapter 6
Benninga, S. (2015). Financial Modeling.
– Chapter 1 (Chapters 2 and 3 are optional)