The Vest-Pocket MBA

The bestselling pocket problem-solver for today's busy executive, now fully revised and updated.

This bestselling, soup-to-nuts book teaches the techniques and methods used in the country's finest MBA programs. Presented in an accessible question-and-answer format, The Vest-Pocket MBA helps readers quickly pinpoint all the formulas, ratios, and rules of thumb they need to analyze and evaluate nearly any problem.

This fully revised fourth edition covers many important business concepts and recent developments, including strategic cost management, balanced scoreboard, global competition, business process reengineering, target pricing, e-marketing, and cloud computing. It also features tools for evaluating any company's financial health and scores of tables, graphs, and charts that simplify complex problems.

The Vest-Pocket MBA offers a wealth of indispensible information for the modern decision-maker, from the B-school student to the senior executive.

Jae K. Shim, Ph.D., is professor of business at California State University, Long Beach, and CEO of Delta Consulting Company, a management consulting and training firm. He has been a consultant to commercial and nonprofit organizations over 30 years, and has over 50 college and professional books to his credit, including The Vest-Pocket CPA and The Vest-Pocket CFO.

Joel G. Siegel, Ph.D, CPA, is a professor of accounting and finance at Queens College of the City University of New York, and is a financial consultant. He is the author of 65 published books and over 300 articles.

Table of Contents

 

THE VEST-POCKET MBA

Acknowledgements

Title Page

Copyright Page

Preface

 

PART ONE - Business Strategy, Management, Marketing, and Legal Strategies

CHAPTER 1 - Strategic Management and Operations Management (OM)

CHAPTER 2 - Management

CHAPTER 3 - Marketing

CHAPTER 4 - Business Law

 

PART TWO - Accounting Tools and Guidelines

CHAPTER 5 - Financial Statements, the Sarbanes-Oxley Act, and Corporate Governance

CHAPTER 6 - How to Evaluate and Improve a Company’s Financial Performance

CHAPTER 7 - Internal Accounting Applications for Your Company

 

PART THREE - Financial Analysis, Metrics, Asset Management, and Financing

CHAPTER 8 - Cost-Volume-Profit Analysis, Operating Leverage, and Time Value of Money

CHAPTER 9 - Capital Budgeting

CHAPTER 10 - Assets Management, Financing Techniques, and Portfolio Theory

 

PART FOUR - Quantitative Methods and Information Technology

CHAPTER 11 - Decision Making with Statistics and Forecasting

CHAPTER 12 - Making Use of Quantitative Decision Making

CHAPTER 13 - Information Technology (IT) and Computer Applications to Business

 

PART FIVE - Economics and Multinational Issues

CHAPTER 14 - Economics

CHAPTER 15 - International Business and Finance

 

Glossary

Index

PORTFOLIO / PENGUIN

THE VEST-POCKET MBA

JAE K. SHIM, Ph.D., is a professor of business at California State University, Long Beach, and CEO of Delta Consulting Company, a management consulting and training firm. He received his M.B.A. and Ph.D. degrees from the University of California at Berkeley (Haas School of Business). Dr. Shim has been a consultant to commercial and nonprofit organizations for more than thirty years.

Dr. Shim, a management consultant, has published numerous articles in such journals as Financial Management , Econometrica, Decision Sciences, Journal of Business Forecasting, Business Economics, Management Science, Management Accounting, The CPA Journal, Long Range Planning, OMEGA, and Journal of Operational Research Society. He has more than fifty college and professional books to his credit, including Operations Management, Strategic Management, Project Management, Managerial Economics, Financial Management , Managerial Accounting, U.S. Master Finance Guide, Barron’s Accounting Handbook, 2011–2012 Corporate Controller’s Handbook of Financial Management , The Vest-Pocket CPA, and The Vest-Pocket CFO. Thirty of his publications have been translated into foreign languages such as Chinese, Spanish, Russian, Polish, Croatian, Italian, Japanese, and Korean. His books have been published by Penguin, McGraw-Hill, Barron’s, CCH, John Wiley, Thomson-Reuters, Amacom, and the American Institute of CPAs (AICPA). Dr. Shim has been frequently quoted by such media as the Los Angeles Times, Orange County Register, Business Start-ups, Personal Finance, and Money Radio. Dr. Shim is the recipient of the 1982 Credit Research Foundation award for his article on financial modeling.

 

JOEL G. SIEGEL, Ph.D., CPA, is a professor of accounting and finance at Queens College of the City University of New York and a financial consultant to management. He is the author of fifty published books and more than two hundred articles. Dr. Siegel’s articles have appeared in professional journals, including The Financial Executive, The Financial Analysts Journal , The CPA Journal, The National Public Accountant, Credit and Financial Management, and the International Journal of Management. He has served as consultant and/or adviser to numerous organizations, including the AICPA, Citicorp, and ITT. He was affiliated with Coopers and Lybrand, CPAs, and Arthur Andersen, CPAs. In 1972 Dr. Siegel was the recipient of the Outstanding Educator of America award. He is listed in Who’s Where Among Writers and in Who’s Who in the World.

 

ALLISON I. SHIM, M.S., is CFO of Delta Consulting/ Investments Company. She is a finance expert and is a Ph.D. candidate at the University of California at Irvine.

Acknowledgments

The authors would like to acknowledge the contributions of Steve W. Hartman, Ph.D., to this edition of The Vest-Pocket MBA. Steve W. Hartman is a management consultant and adviser to companies and a professor of management at the Graduate School of Business at New York Institute of Technology. He has authored several books and has written numerous articles in professional business journals.

PORTFOLIO / PENGUIN

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This fourth edition published 2011

 

 

Copyright © Penguin Group (USA) Inc., 1986, 1997, 2004, 2011 All rights reserved

 

PUBLISHER’S NOTE

 

LIBRARY OF CONGRESS CATALOGING IN PUBLICATION DATA

Shim, Jae K.

The vest-pocket MBA / Jae K. Shim, Joel G. Siegel, Allison T. Shim.—4th ed.

p. cm.

Includes index.

ISBN: 9781101575574

1. Managerial accounting. 2. Business enterprises—Finance. I. Siegel, Joel G. II. Shim, Allison I., 1984–III. Title.

HF5657.4.S452 2012

658.15’11—dc23 2011040455

 

 

 

The scanning, uploading, and distribution of this book via the Internet or via any other means without the permission of the publisher is illegal and punishable by law. Please purchase only authorized electronic editions, and do not participate in or encourage electronic piracy of copyrighted materials. Your support of the author’s rights is appreciated.

Preface

Here is a handy pocket problem solver for today’s busy executive. It is a working guide to help you quickly pinpoint in the complex world of business:

• What to look for

• What to do

• What to watch out for

• How to do it

You will find ratios, formulas, guidelines, and rules of thumb to help you analyze and evaluate any business-related problem. Throughout, you will find this book practical, quick, and useful.

Uses for this book are as varied as the topics presented.

Part I (Chapters 1, 2, 3, and 4) takes you through the world of business strategy, management, marketing, and legal environments of business. You will learn strategic analysis, various management techniques, production /operations management, the marketing process of planning and distribution, and how to price and promote products. These management and marketing techniques and processes have been presented in an extremely understandable and practical format to make them as useful as possible. The statutory and case laws affecting business operations and decisions are also presented. Legal requirements must be known to protect the business entity.

Part II (Chapters 5, 6, and 7) takes you through accounting principles and guidelines for evaluating a company’s financial health. You will have an increased understanding of various financial statements and their implications. You will be exposed to Corporate Responsibility Law, better known as the Sarbanes-Oxley (SOX) Act. You will learn techniques for analyzing another company’s financial position should you wish to invest, extend credit, or compare. You will also learn how to improve a company’s corporate profitability and shareholder value. We present internal managerial accounting applications to help you evaluate your own company’s performance, profitability, marketing effectiveness, and budgeting process. You will learn how to highlight problem areas with variance analysis. You will also learn some valuable new tools, such as activity-based costing (ABC), life-cycle costing, target costing, and corporate balanced scorecard.

Part III (Chapters 8, 9, and 10) takes a look at financial analysis tools, financial metrics, and financing methods for decision making. Through break-even and sensitivity analysis, you will be able to move your company toward greater profits. For investment purposes, this part presents guidelines for evaluating proposals, whether they be short or long term, for profit potential and risk-return comparisons. You will learn management and financing techniques to ensure the best possible strategies for maximizing and acquiring cash. Also covered are basic financial tenets of portfolio theory, the capital asset pricing model (CAPM), and the arbitrage pricing model (APM).

Part IV (Chapters 11, 12, and 13) takes you through the seemingly complex world of quantitative analysis and information technology (IT). You will use statistics for forecasting and validity testing. Decision tools and techniques include linear programming, learning curve theory, project management, and queuing models; these are presented concisely and comprehensively to help you use such sophisticated techniques with relative ease. In addition, you will learn how computer applications facilitate the many complex procedures. Computer applications are heavily stressed throughout the chapters. Chapter 13 takes up the issue as to how IT assists managers in business decisions. It covers the use of information systems in all phases of business and in all functional areas to analyze and solve business problems in the “real world.”

Part V (Chapters 14 and 15) covers the economic issues of interest to business managers, because they have a significant impact upon corporate success or failure. Attention should be given to the changing economic environment as well as economic indices and statistics in making financial and investment decisions. Many companies are multinational, so business managers must understand the opportunities and difficulties associated with international business and multinational finance. Some relevant issues of concern to businesspeople are foreign exchange rates, currency risk management, political risk, and international sources of financing.

This book has been designed in question-and-answer format in order to address the pertinent issues that come up during the course of business. The questions are typical of those asked by persons like you. The answers are clear, concise, and to the point. In short, this is a veritable cookbook of guidelines, illustrations, and “how-tos” for you, the modern decision maker. Keep it handy for easy reference throughout your busy day.

 

Jae K. Shim

 

Joel G. Siegel

 

Allison I. Shim

PART ONE

Business Strategy, Management, Marketing, and Legal Strategies

CHAPTER 1

Strategic Management and Operations Management (OM)

This chapter provides a discussion of strategic management and production and operations management (P/ OM), including

Mission statement

Strategic management

Strengths, Weaknesses, Opportunities, and Threats (SWOT) analysis

Management decision making

Simulation

Capacity management

Location analysis

Time-study procedures

Aggregate planning schedules

Inventory management

Scheduling, including project scheduling

Strategy can be defined as a course of action or a plan, including the specification of resources required, to achieve a specific objective. All business organizations have objectives, but because of the dynamic nature of the organizations’ environments, overall plans or strategies are needed to specify in broad terms just how the objectives of the organizations can be achieved, given the uncertainty of the environments.

Strategic management is therefore concerned with deciding on a strategy and planning how that strategy is to be effected. As such, strategic management has general relevance in that it is relevant for managers in all types of organizations—profit-seeking and nonprofit organizations, state and private sector.

Production and operations management (P/OM) is a vital management activity in both manufacturing and service organizations. It is primarily concerned with the process of transforming organizational resource inputs into final organizational outputs. It is a comprehensive process that treats the organization as a system of interconnected functions. The major functions of P/OM incorporate design, planning, decision making, operations, and system controls.

1.1 THE ORGANIZATIONAL MISSION STATEMENT

What is the purpose of a mission statement?

A mission statement describes the basic operational intent of an organization. It takes a long-term perspective and states the reason for a firm’s existence. Its function is to provide guidance for the firm’s shareholders, customers, and employees about the organization’s overall direction and rationale.

How is a mission statement developed?

A mission statement should be consistent with the organization’s history, including past achievements, organizational culture, attributes, and basic policies. A new organization will take into consideration the history of the industry it is joining as well as the purpose it wishes to serve. Successful mission statements emphasize areas in which an organization has its greatest strengths and resources.

What are the key elements of a mission statement?

A mission statement must be

• Meaningful for the organization’s client or customer base. Organizations must be constantly aware of who their clientele is, and of its requisite needs.

• Realistic and attainable. Unrealistic mission statements will cause an organization to fail.

• Stimulating and inspiring. A motivational mission statement will enhance employee creativity and commitment.

• Definitive and explicit. Unclear mission statements result in dispersed and unsuccessful organizational strategies.

Example 1.1

An independent power producer states that its mission consists of four central values:

Integrity: To act with integrity and honor commitments.

Fairness: To treat fairly employees, customers, suppliers, and the governments and communities in which the organization operates.

Fun: To create and maintain an atmosphere in which employees can advance in their skills while enjoying their time at work.

Social Responsibility: To undertake projects that provide social benefits, such as lower costs to customers, a high degree of safety and reliability, increased employment, and a cleaner environment.

 

Example 1.2

 

A rapidly growing petroleum company states that its mission is to create value by adding substantial oil and gas reserves while minimizing geological risk and leveraging staff expertise.

 

Example 1.3

 

A company that introduced the first independent electronic product information database that uses the industry standard Universal Product Code (UPC) numbering system states that its mission is to provide quality electronic merchandise management services and technologies to the retail industry.

1.2 STRATEGY MANAGEMENT PROCESS

Basically, strategic management can be broken down into three phrases: strategy planning and strategy formulation, strategy implementation, and strategy evaluation.

Strategy planning and strategy formulation involves the following steps:

1. Defining the organization’s guiding philosophy, purpose, and mission.

2. Establishing long-range objectives to achieve the mission.

3. Selecting the strategy to achieve the long-range objectives.

Strategic implementation is concerned with aligning the organizational structure, systems, and processes with the chosen strategy. It involves making decisions with regard to:

1. Developing an organizational structure, selecting leadership, and providing motivational systems to achieve the strategy.

2. Establishing short-range objectives, developing budgets, and developing functional strategies to achieve the strategy.

Strategy evaluation, sometimes referred to as strategic evaluation and control, involves the following activities:

1. Establishing standards of performance for the overall organization and its different units or functional areas.

2. Monitoring progress in the execution of the organization’s strategy. This requires assessing and measuring the implementation of the strategies pursued by different units throughout the organization.

3. Initiating corrective actions to ensure continued commitment to the implementation of the strategy. Taking corrective actions requires the timely dissemination of feedback data to the managers of the organization’s different units, its top executives, and members of its board of directors.

What is the purpose of an organizational strategy?

The purpose of an organizational strategy is to achieve the goals of the mission statement. This is done by developing a logical plan for utilizing the organization’s strengths and resources. An organizational strategy provides direction for the organization’s activities and its human resources within the context of its mission statement’s objectives.

What strategy must an organization develop to achieve its mission?

An organizational strategy must be developed for each functional area within an organization’s mission statement. The resulting strategies contain

1. A clear purpose

2. Measurable expected outcomes

3. Fall-back plans in the event the primary strategy cannot be implemented

4. Costs and benefits

Developing an organizational strategy using the Strengths, Weaknesses, Opportunities, and Threats (SWOT) analysis.

To use SWOT analysis is to combine the assessment of the environment with the analysis of the organization’s internal resources and capabilities. The key objective is to arrive at a strategic fit—the matching of strength to opportunities, the elimination or avoidance of threats, and the strengthening or avoidance of weaknesses.

Elements analyzed within the organization’s environment consist of the following variables:

1. culture

2. demographics

3. economic technology

4. organizational publics

a. capital originators including shareholders, creditors, bankers, and underwriters

b. raw material and component providers

c. customers

d. human resources

e. competitive rivals

f. governmental and legal entities, including regulators

g. special-interest lobbying groups

The SWOT analysis allows managers to develop a strategic plan by examining organizational strengths and weaknesses in terms of the opportunities and threats presented by the organization’s environmental elements. Subsequent strategies and tactical decisions can produce a competitive advantage.

What does strategic analysis seek?

Strategic analysis seeks to understand the strategic position of the organization. The analysis should encompass the environment, resources, objectives, expectations, and behaviors of the organization. Strategic choice concerns the formulation of possible courses of action, the evaluation of the courses of action, and the choice between them. Strategic implementation is the planning of how the strategy can be put into effect. Implementation affects all aspects of the organizational system.

More specifically, strategic analysis is concerned with the understanding of the strategic position of the organization, and will thus seek to analyze

The mission—What business are we in? Why does the business exist at all? What is the value system of the business?

The goals—The goals reflect the specific relevance of the mission to the various stakeholders.

The objectives—Embodying the mission, objectives are quantifiable and are used to measure actual performance.

The external environment—This analysis involves the scanning of the environment for factors relevant to the organization’s current and future activities.

The internal appraisal or position audit—This is an assessment of the current state of an organization in terms of resources, assets, facilities, and performance values.

The corporate appraisal—This is the evaluation of the strengths, weaknesses, opportunities, and threats (SWOT) in relation to the environmental factors.

The gap analysis—This involves identifying the gap between where we are now, where we will be when extrapolated, and where we desire to be.

Selection of appropriate strategies and creation of strategic business units (SBUs)—Businesses should be defined in market terms, that is, in terms of needs and customer groups. Moreover, a distinction should be made between a target market definition and a strategic market definition. For example, a target market for a railroad might be freight hauling, but a strategic market might be transportation of any goods and people. A business also may be defined with respect to customer groups, their needs, and the technology required to satisfy those needs. A large firm has multiple businesses. Thus, the concept of the strategic business unit (SBU) is useful for strategic planning by large firms. An SBU is a business (or a group) for which separate planning is possible. An SBU also has its own competitors and a manager who engages in strategic planning and is responsible for the major determinants of profit. Determining the strength of each SBU with respect to its potential markets and the position of businesses in those markets is called business portfolio management.

Implementation of the chosen strategies—Strategic plans must be filtered down the organizational structure through development of plans at each lower level that are congruent with higher-level plans. This process is most likely to succeed if the structure is compatible with strategic planning, personnel have the necessary abilities, the organizational culture is favorable or can be changed, and controls exist to facilitate implementation.

What are the three levels of planning? How are they related?

There are, in general, three levels of strategy: corporate strategy, business strategy, and functional strategy. Corporate strategies define what business or businesses the firm is in or should be in, and how integrated these businesses should be with one another. Business strategies define how each business attempts to achieve its mission within its chosen area of activity. Functional strategies govern how the different functions of the business (marketing, production, sales, finance, HRM, IT, etc.) support the corporate and business strategies.

These levels of strategies are matched by the three levels of planning: strategic planning, tactical planning, and operational planning. Strategic planning defines the objectives of the organization, changes in these objectives, the resources needed to attain these objectives, and the policies that are to govern the acquisition, use, and disposition of said resources. Tactical planning ensures that the resources are obtained and used effectively and efficiently in the accomplishment of the organization’s objectives. Operational planning ensures that specific tasks are carried out effectively and efficiently.

1.3 MANAGERIAL DECISION MAKING

All managers suffer from a shortage of knowledge, resources, and time. Working within these parameters, the management process culminates in decisions to implement various actions. Decision making is the focal point of all organizational dynamics, and management effectiveness is judged on the basis of the quality of these decisions.

What is managerial decision making?

Managerial decisions are deliberate choices made from a range of alternatives. Before making a decision, a manager must evaluate each choice according to its projected outcomes in terms of the organization’s resources as well as the amount of information and time available. Thus, every managerial decision is a best-effort compromise made in an environment of uncertainty.

What are the types of management decisions?

From a management perspective, there are three types of decisions:

1. Long-term strategic decisions concerning the external environment of the organization.

2. Administrative decisions intended to order the functions of the organization in the most cost-effective way.

3. Operational decisions designed to maximize a firm’s profitability through productive procedures.

What are the types of strategic decisions?

There are many types of strategic decisions in production and operations management (P/OM):

1. Product or service strategy. Management decisions regarding product-line market strategies (including design, quality, and cost) determine production cost parameters.

2. Process strategy. Management decisions regarding process methods are critical in determining technological and organizational production requirements. The process strategy decision is also crucial in determining capital and financial requirements.

3. Research and development (R&D) strategy. R&D is critical for organizational survival in today’s rapidly changing marketplace. The R&D strategy includes total resources being devoted to an effort and the type of research to be performed, including pure vs. applied research, manufacturing vs. market research, and product vs. process development.

4. Location strategy. Often the success or failure of a business, production, or service is determined by a location decision.

5. Inventory management strategy. It is essential to develop a strategy for coordinating production needs with raw material and component inventories. However, the inventory strategy is determined by whether the demand is dependent on or independent of the demand for other components. If the demand for one product, such as air conditioners, is independent of that for another product, such as kitchen chairs, an independent inventory management strategy is required. However, if the overall component demand is dependent on the demand for the product, a material requirements planning (MRP) strategy is needed. MRP is a component-manufacturing planning method in which items required for a manufacturing process are indexed to overall product demand. With MRP it is not essential that all inventory items be available at all times, but that they be available only when they are required in the production process. Thus, under MRP, inventory needs are coordinated with production needs. (See Chapter 12, on inventory management, for a more complete discussion.)

6. Human resource planning and management strategy. As a rule of thumb, more than 75 percent of a firm’s operating expense is for human resources. Therefore, adequate hiring, training, and utilization of human resources is a critical operational strategy for achieving success.

Example 1.4

The management of an organization makes a strategic decision to develop a five-year marketing plan to achieve a competitive advantage through the introduction of a new service.

 

Example 1.5

An automobile manufacturer makes a process strategy decision to offer a standard group of options on its automobiles in order to reduce the variation in its production needs and lower unit costs.

 

Example 1.6

A computer-chip manufacturer makes a strategy decision to increase R&D expenditures on an advanced CPU chip design, enabling compatibility with multiple computer operating systems.

 

Example 1.7

A firm makes a location strategy decision to conduct a nationwide survey of state industrial development agencies to evaluate in which locations the company would receive the greatest financial and environmental benefits.

 

Example 1.8

A lawn-mower and snow-blower manufacturer makes an inventory management decision to use an MRP system to coordinate the need for lawn-mower and snow-blower components with seasonal manufacturing schedules.

Example 1.9

A manufacturer makes a human resource strategy decision to give more responsibility to its employees by creating work teams to assemble entire products rather than components in the belief that it will obtain greater productivity as a result of job enrichment.

What are the types of administrative decisions?

1. Programmed decisions. Decisions typically made regarding highly routine situations, in which little discretion is required.

2. Nonprogrammed decisions. Decisions made in unstructured situations, in which problem conceptualization and original thinking are required.

Example 1.10

Management