u .... ... .---544 ACCOUNTING AND ENGINEERINGECONOMY
ratio or quick ratio becomes important when one wishes to consider the finn's ability to
pay debt "instantly."The acid-test ratio is computed by dividing a finn's quick assets (cash,
receivables, and market securities) by total current liabilities, as in Equation 18-4.Acid-test ratio=Quick assets/Total current liabilities (18-4)
Current inventoriesare excluded from quick assetsbecause of the time required to sell these
inventories, collect the receivables, and subsequently have the cash on hand to reduce debt.
For Engineered Industries in Figure 18-2 the calculated acid-test ratio is well below the
current ratio [(1,940,000 + 950,000)/2,180,000=1.33].
Working capital, current ratio, and acid-test ratio all provide an indication of the finn's
financialhealth (status). A thorough financial evaluationwould consider all three, including
comparisons with values from previous periods and with broad-based industry standards.THEINCOME STATEMENT
The income statement or profit and loss statement summarizes the finn's revenues and
expenses over a month, quarter, or year. Rather than being a snapshot like the balance sheet,
the income statement encompasses aperiod of business activity. The income statement
is used to evaluate revenue and expenses that occur in the intervalbetweenconsecutive
balance sheet statements. The income statement reports the finn'snet income (profit)or
lossby subtracting expenses from revenues. If revenues minus expenses is positive in
Equation 18-5 there has been a profit, if negative a loss has occurred.Revenues - Expenses=Net profit (Loss) (18-5)
Revenue, as in Equation 18-5, serves to increase ownershipin a finn, while expenses serve
to decrease ownership. Figure 18-3 is an example income statement.
To aid in analyzing perfonnance, the income statement in Figure 18-3 separates op-
erating and nonoperating activities and shows revenues and expenses for each. Operating
revenues are made up of sales revenues (minus returns and allowances),while nonopex:ating
revenues come from rents and interest receipts...
Operating expenses produce the products and services that generate the finn's revenue
stream of cash flows. Typical operating expenses include cost of goods sold, selling and
promotion costs, depreciation, general and administrativecosts, and lease payments.Cost
of goods sold (COGS)includes the labor, materials, and indirect costs of production.
Engineers designproduction systems, and they are involvedin labor loading, specifying
materials, and make/buy decisions. All these items affect a finn's cost of goods sold. Good
engineering design focuses not only on technical functionalitybut also on cost-effectiveness
as the designintegratesthe entire production system. Also of interest to the engin~ering
economist isdepreciation(see Chapter 11)-which is the systematic "writing off" of a cap-
ital expense over a period of years. This noncash expense is importantbecause it represents
a decrease in value in the finn's capital assets.
The operating revenues and expenses are typically shown first, so that the finn's oper-
ating income from its products and services can be calculated. Also shown on the income