Principles of Managerial Finance

CHAPTER 1 The Role and Environment of Managerial Finance 11

accrual basis
In preparation of financial
statements, recognizes revenue
at the time of sale and recognizes
expenses when they are
incurred.

cash basis
Recognizes revenues and
expenses only with respect to
actual inflows and outflows of
cash.

EXAMPLE Jamie Teng is a financial manager for Nord Department Stores, a large chain of

upscale department stores operating primarily in the western United States. She is

currently trying to decide whether to replace one of the firm’s online computers

with a new, more sophisticated one that would both speed processing and handle

a larger volume of transactions. The new computer would require a cash outlay

of $80,000, and the old computer could be sold to net $28,000. The total bene-

fits from the new computer (measured in today’s dollars) would be $100,000.

The benefits over a similar time period from the old computer (measured in

today’s dollars) would be $35,000. Applying marginal analysis, Jamie organizes

the data as follows:

Because the marginal (added) benefits of $65,000 exceed the marginal (added)

costs of $52,000, Jamie recommends that the firm purchase the new computer to

replace the old one. The firm will experience a net benefit of $13,000 as a result

of this action.

Relationship to Accounting

The firm’s finance (treasurer) and accounting (controller) activities are closely

related and generally overlap. Indeed, managerial finance and accounting are not

often easily distinguishable. In small firms the controller often carries out the

finance function, and in large firms many accountants are closely involved in var-

ious finance activities. However, there are two basic differences between finance

and accounting; one is related to the emphasis on cash flows and the other to

decision making.

Emphasis on Cash Flows

The accountant’s primary function is to develop and report data for measuring

the performance of the firm, assessing its financial position, and paying taxes.

Using certain standardized and generally accepted principles, the accountant pre-

pares financial statements that recognize revenue at the time of sale (whether pay-

ment has been received or not) and recognize expenses when they are incurred.

This approach is referred to as the accrual basis.

The financial manager, on the other hand, places primary emphasis on cash

flows,the intake and outgo of cash. He or she maintains the firm’s solvency by plan-

ning the cash flows necessary to satisfy its obligations and to acquire assets needed

to achieve the firm’s goals. The financial manager uses this cash basisto recognize

the revenues and expenses only with respect to actual inflows and outflows of cash.

Benefits with new computer $100,

Less: Benefits with old computer  (^3)  (^5) , (^0)  (^0)  (^0) 
(1) Marginal (added) benefits $65,
Cost of new computer $ 80,
Less: Proceeds from sale of old computer  (^2)  (^8) , (^0)  (^0)  (^0) 
(2) Marginal (added) costs  (^5)  (^2) , (^0)  (^0)  (^0) 
Net benefit [(1)(2)] $

1

3

,

0

0

0