Chapter 16 -

Accounting, Economics
and Financial
Management Basics

Management for Engineers,

Technologists and
Scientists
Study Objectives - Ch. 16

 explain product demand and supply

 explain the function of the various
financial statements
 differentiate between different
types of costs
 apply the CVP method in decision
making
 Chapter 16

Engineers are involved in the following

financial management tasks (p. 336):
 Evaluating projects

 Planning and controlling budgets

 Cost estimating

 Analysing of economic risks

 Chapter 16 - Models

 Bookkeeping Model - classifying, recording,

and reporting financial transactions
 Cost-Volume-Profit Model: Decision making
regarding selling price, sales volume &
product mix.
 Budget and performance analysis model -
Ch. 17
 Net Present Value Model: Capital
investment decisions.
Chapter 16 - Economics

“Economics is the science which studies

human behaviour as a relationship
between ends and scarce means which
have alternative uses.”
(Lord Robbins)
 Economics provide answers to
the following questions:

 What commodities are to be

produced and in what quantities?
 When should these be produced?
 How shall goods be produced? By
whom, with what resources and in
what technological manner?
 For whom shall goods be produced?
 Chapter 16

Example: Why the cost of an asset may

be a poor indicator of its value

A mine shaft system may cost R2 billion

to develop but it may have no or very
little economic value if it is not
providing access to an ore body that
can be mined at a profit.
 Chapter 16

Factors to consider when evaluating an

asset for investment purposes (p. 338):
• amount of expected return or income
• timing of income
• risk associated with return
 Invest in a project when (p. 338):
 NPV > 0
 IRR > hurdle rate
 Chapter 16

 Economic efficiency = worth / cost;

must be greater than 100%
 Resources used by organisations:
• land (natural resources)
• labour (operate machines)
• capital (e.g. machinery & equipment)
• enterprise (entrepreneurs)
• knowledge (primary resource?)
 Chapter 16

 Law of diminishing returns (p. 339)

 Returns to scale (p. 340)
 Opportunity cost (p. 341)
 When evaluating a number of projects
 Which projects will create wealth?
 Which projects should the company choose
if the necessary capital is not available to
invest in all those with a positive net
present value?
 Quantity demanded of
product X (p. 341)
 Qd,x = Qd,x(Px, Y, P1, …,, Pn, T, A)
where:
 Px is the price of product x
 Y is the level of household income
 P1, ..., Pn refers to prices of other related
products e.g. substitutes and complements
 T refers to the tastes of consumers
 A refers to advertising
 Quantity of product X that
businesses will supply
 Qs,x = Qs,x(Px, P1, …,, Pn, F1, …, Fm, T, Z)
where:
 Qs,x refers to the quantity supplied
 Px refers to the price of product X
 P1 - P n = prices of other products
 F1 - Fm = factors of production costs
 T refers to the state of technology
 Z - other factors
 Chapter 16

 Difference between:
 Balance sheet
 Income statement
 Cash flow statement
 The effect of the following transactions
on cash flow (p. 346):
• An increase in stock
• An increase in debtors
• An increase in creditors
 Balance sheet
Employment of capital

Current assets Current liabilities

 Inventories  Short-term loans

 Debtors  Trade creditors
 Prepaid accounts  Tax provisions
 Deposits  Bank overdrafts
 Cash  Dividends to be
 Short-term paid
investments  Interest due

Fixed assets Capital employed

 Land Long term liabilities

 Buildings
 Plants  Mortgage on land
 Vechicles  Bond on building

Intangible assets Owner’s equity

 Patents  Share capital

 Reserves
 Nature of cost

Variable costs
Rand

Volume

Fig. 16.7 Representation of variable costs (p. 347)

 Nature of cost

Rand Fixed costs

Volume

Fig. 16.8 Representation of fixed costs (p. 347)

 Cost-Volume-Profit
(break-even) analysis
 Questions answered with CVPA:
• “What volumes are required to break-even
• What volumes are required to achieve the
planned profit?
• What profit will a given sales volume yield?
• What price?
• Effect of expansion on sales, etc.
 CVP Example
Blue Sky Airways provides a daily service between
Johannesburg and Durban. The aircraft has a capacity of
220 passengers and each trip costs the company R70
000, regardless of the number of passengers. Additional
costs are R60 per passenger (baggage, cabin services and
booking costs).
a) If Blue Sky Airways charge R450 per passenger,
how many passengers do they need to break even
with each flight?
b) Research showed that planes are actually carrying
an average of 80% of its capacity of passengers.
What profit (or loss) is realised at 80% capacity and
R450 per ticket?
c) What price should Blue Sky Airways charge if they
want to realise a profit of R100 000 on each trip (at
80% capacity)?