BUDGETING TECHNIQUES AND PERFORMANCE EVALUATION Flashcards
(200 cards)
1
Q
What is the primary purpose of budgeting?
A
Profit planning
Budgeting should be thought of as a strategic approach to planning profits.
2
Q
What are the three kinds of accounting used in budgeting?
A
Cash, accrual, modified accrual
Each accounting method records revenues and expenses differently.
3
Q
How does budgeting impact organizational behavior?
A
It should not impair the flow of information.
4
Q
What is the significance of real estate as an investment?
A
It is an important investment that requires financial tests to measure soundness.
5
Q
Name three financial ratios used to assess investment performance.
A
Internal rate of return (IRR), return on investment (ROI), payback period.
6
Q
What does break-even analysis help determine?
A
When a property covers its costs and generates cash flow.
7
Q
What does net present value (NPV) measure?
A
Future profitability in current dollars.
8
Q
What are the learning objectives related to budgeting techniques?
A
Implement budgeting techniques, assess profitability, enhance budgeting process, understand time value of money, analyze break-even point.
9
Q
Fill in the blank: The time value of money distinguishes between _______ and present value of a sum.
A
future value.
10
Q
True or False: Involving all staff members in the budgeting process can enhance communication.
A
True.
11
Q
What is the goal of assessing the profitability of a real-estate investment?
A
To use various techniques, ratios, and measures.
12
Q
What does analyzing a break-even point involve?
A
Interpreting the results.
13
Q
What is cash-basis accounting?
A
Revenues are declared in the accounting period in which the cash is received. Expenses are declared in the accounting period in which cash is paid out.
14
Q
What is accrual-basis accounting?
A
Revenues are declared in the accounting period in which they are earned, and expenses are declared in the accounting period in which the expense is incurred.
15
Q
What is modified accrual accounting?
A
Some revenues and expenses are declared on a cash basis and some on an accrual basis, typically revenues on accrual basis and expenses on cash basis.
16
Q
Fill in the blank: In cash accounting, revenues are declared when _______.
A
cash is received
17
Q
Fill in the blank: In accrual accounting, expenses are declared when _______.
A
the expense is incurred
18
Q
What is a key difference between tax returns and other financial accounting reports?
A
Tax returns often differ substantially due to tax rules aimed at encouraging or discouraging certain business activities.
19
Q
What is one of the real estate manager’s most important functions?
A
To keep records of every financial transaction of properties.
20
Q
Why are accurate records of financial transactions essential?
A
They provide a clear audit trail and are used for budgeting, estimating value, and analyzing differences between budgeted and actual amounts.
21
Q
True or False: Home mortgages receive special tax treatment compared to other real estate investments.
A
True
22
Q
What does modified accrual accounting declare on a cash basis?
A
Expenses
23
Q
What does modified accrual accounting declare on an accrual basis?
A
Revenues
24
Q
Fill in the blank: Accurate records allow for predicting future _______ and _______.
A
revenues and expenses
25
What does computerized record-keeping software simplify?
Many traditional accounting tasks
## Footnote
This includes storing rent rolls, tenant data, tracking expenses, and capturing accounting activity.
26
What are the three main applications of property management software?
* Stores the rent roll and tenant data
* Keeps track of expenses
* Captures all accounting activity
27
Why should companies be open to ideas from staff members without budgeting responsibilities?
They may have ideas that can cut costs and enhance productivity
## Footnote
Staff closest to a situation often know how to organize their work effectively.
28
Who is considered the 'father' of Total Quality Management (TQM)?
W. Edwards Deming
## Footnote
Deming emphasized the importance of statistical techniques in improving quality.
29
What is one of Deming's beliefs regarding organizational structure?
Artificial divisions between staff departments should be eliminated.
30
What is necessary for permanent improvement in performance according to Deming?
Measurements must be used.
31
What must budgeting be based on?
The best information possible
## Footnote
This includes identifying and learning from last year's mistakes.
32
What is the primary customer in real estate management?
The tenant.
33
How can cutting back on budget line items for cosmetic repairs affect tenant perception?
It may be perceived as the beginning of the building's deterioration.
34
Fill in the blank: Permanent improvement in performance is not possible without _______.
[measurements]
35
What is the time value of money?
The concept that money has a different value over time and people will pay to use others' funds
36
What is return in the context of investments?
Money made on investments
37
Define rate of return.
The percentage of the increase of the initial investment
38
What does compounding refer to?
Finding the future value of a current dollar amount by adding interest over time
39
What is discounting?
Finding the present value of a future dollar amount
40
What is the difference between interest rate and discount rate?
Interest rate is used in compounding, while discount rate is used in discounting
41
What is future value?
How much an investment will be worth after a certain period of time
42
Give an example of future value.
Putting $1,000 in a savings account paying 4 percent interest for five years
43
What is present value?
Calculating how much money must be set aside now for future use at a certain interest rate
44
If a real estate manager needs $250,000 in four years, what financial concept is used to determine how much to invest now?
Present value
45
How does the time value of money impact capital budgeting decisions?
It helps in finding present value of future income and future value of today's investments
46
Fill in the blank: Money made on investments is known as _______.
return
47
True or False: Compounding involves finding the present value of a future sum of money.
False
48
What is the formula to determine the future value of an investment?
Future Value = Present Value * (1 + interest rate)^number of periods
49
What does an investor need to calculate to have sufficient funds available for a future expense?
Present value of the future expense
50
Fill in the blank: The rate at which money accumulates in compounding is called the _______.
interest rate
51
What is a practical example of future value in real estate?
Investments in buildings over long periods of time
52
What is the formula for finding an investment's future value?
FV = PV x (1 + i)n
53
What does FV stand for in the future value formula?
Future value
54
What does PV represent in the future value formula?
Present value
55
What does 'i' denote in the future value formula?
Earnings rate for each compounding period
56
What does 'n' indicate in the future value formula?
Number of compounding periods
57
True or False: The number of compounding periods is always equal to the number of years of an investment.
False
58
How many compounding periods are there in a five-year investment compounded monthly?
60 compounding periods
59
If the present value is $1,000, the interest rate is 0.04, and the investment duration is 5 years, what is the future value?
$1,216.65
60
Fill in the blank: Future value applies to _______ and investments.
[savings accounts]
61
What is the future value of $5,000 at 5 percent interest, compounded monthly, for 6 years?
[calculation needed]
62
True or False: You need to know how to use the future value formula to calculate future value using a financial calculator.
False
63
What is the significance of future value in financial decisions?
It is the reason people make investments
64
What type of calculator can simplify future value calculations?
Scientific calculator
65
What is the future value of an investment calculated using the formula?
The amount of money accumulated after n compounding periods
66
What menu does the keystroke [FIN](TVM] display?
TVM (time value of money) menu
67
What does the keystroke [OTHER] 12 set?
12 payments a year, end mode
68
What is the value of P/YR when set to 12?
12.00
69
How many payments are there over six years?
72.00
70
What is the interest rate set by I%YR?
5.00
71
What is the initial deposit represented as PV?
-5,000.00
72
What is the future value (FV) calculated?
6,745.09
73
True or False: Present value involves working 'backwards' from a future financial goal.
True
74
What does capital budgeting entail?
Determining how much money to set aside now for a future purchase or major expense
75
How does a higher interest rate affect present value?
It lowers the present value of money
76
Fill in the blank: Discounting has a large effect on the _______.
value of money
77
What is the formula for calculating present value?
PV = FV/(1 + i)n
## Footnote
PV = Present Value, FV = Future Value, i = interest rate, n = number of periods
78
What does the term (1 + i)n represent in the present value formula?
It acts as a divisor in the equation
## Footnote
It shows how future value is adjusted to find present value
79
How does the concept of present value appear counterintuitive?
It suggests that money can 'work backward'
## Footnote
This means that the value of money decreases over time due to interest rates
80
If you need $250,000 in four years at an interest rate of 7%, what is the present value?
$190,723.22
## Footnote
This is calculated using the formula PV = 250,000/(1 + 0.07)^4
81
What does the present value calculation help determine?
The worth of a single investment at a certain interest rate after a set number of time periods
## Footnote
It is a fundamental concept in the time value of money
82
True or False: Financial calculators do not require knowledge of the present value formula to perform calculations.
True
## Footnote
Users can input values directly without knowing the underlying formulas
83
Fill in the blank: The present value formula is used to determine what a _______ will be worth in the future.
single investment
84
What is the significance of using a scientific calculator or financial calculator for present value calculations?
It simplifies the computation process
## Footnote
Different calculators may have specific functions for financial calculations
85
What does TVM stand for?
Time Value of Money
## Footnote
TVM is a financial concept that describes how the value of money changes over time due to interest rates.
86
What is the formula to set the number of interest payments for four years in this example?
N=4.00
## Footnote
N represents the total number of payment periods.
87
How many payments are made per year in this scenario?
1 PMTS/YR: END MODE
## Footnote
This indicates one payment at the end of each year.
88
What is the interest rate set in this example?
I% YR=7.00
## Footnote
The interest rate is the percentage that will be applied to calculate interest.
89
What is the future value desired in this calculation?
FV=250,000.00
## Footnote
FV represents the amount of money that is desired in the future.
90
What is the present value calculated in this example?
PV=-190,723.80
## Footnote
PV is the current worth of the future money, discounted at the interest rate.
91
True or False: The two answers in the calculation are exactly the same.
False
## Footnote
There is a difference of 57 cents in the two answers, indicating a rounding issue.
92
What should you do if the answer from a calculator seems strange?
Make a rough estimate of the result you are seeking
## Footnote
This helps in identifying potential errors in calculations.
93
Fill in the blank: Calculators vary in how they handle _______.
rounding
## Footnote
Rounding can affect the final output of financial calculations.
94
What is the significance of programming in calculators?
Programming of calculators varies slightly
## Footnote
This variation can lead to different results for the same calculations.
95
What are the two important measures used in evaluating investments?
Net present value (NPV) and internal rate of return (IRR)
## Footnote
These measures help determine whether a project is an acceptable investment.
96
What is net present value (NPV)?
The difference between the present value and the actual cost of the investment
## Footnote
NPV is used to assess the profitability of an investment by calculating future cash flows.
97
How is NPV calculated?
Present value - initial investment
## Footnote
Both the initial investment amount and the discount rate must be known for the calculation.
98
If an apartment building is bought for $200,000 and its present value is calculated as $215,523, what is the NPV?
15,523
## Footnote
NPV is calculated as 215,523 - 200,000.
99
What does it mean if the NPV equals zero?
The investment's yield is equal to the minimum desired rate of return
## Footnote
This indicates that the investment meets the minimum financial objective.
100
What does a positive NPV indicate?
The investment's yield is more than the minimum rate of return
## Footnote
A positive NPV suggests the project may be a good investment.
101
What does a negative NPV imply about an investment?
The investment is not attractive, even at the minimum rate of return
## Footnote
This could change if a lower price can be negotiated.
102
Fill in the blank: Present value is found using a desired rate of return after considering the project's _______.
riskiness and other favorable and unfavorable aspects
## Footnote
This evaluation helps determine the present value.
103
What is the relationship between NPV and the time value of money?
NPV is directly related to the time value of money
## Footnote
It works by discounting future cash flows to present value.
104
What must be known to calculate NPV?
The initial investment amount and the discount rate
## Footnote
These are essential for determining the present value of future cash flows.
105
What does NPV stand for?
Net Present Value
## Footnote
NPV is a financial metric used to evaluate investments by discounting cash flows.
106
Why is NPV particularly helpful?
It is helpful when an investment has highly variable cash flows, such as residential buildings with changing rents.
## Footnote
NPV assumes cash inflows will be reinvested.
107
What does NPV estimate in property negotiations?
It estimates the best and worst negotiating positions.
## Footnote
The rate of return can be adjusted in the present value equation to yield different values.
108
What is the internal rate of return (IRR)?
The specific discount rate for which the net present value is zero.
## Footnote
IRR equates the present value of cash inflows to the equity or investment.
109
What does IRR provide as a result?
A percentage that indicates the rate of return, used as an indicator of project attractiveness.
## Footnote
Unlike NPV, which gives a monetary value, IRR gives a rate.
110
How is IRR derived?
It is derived from the present-value equation.
## Footnote
The unknown discount rate is solved when the net present value is set to zero.
111
What happens if the IRR equals the company's desired rate of return?
The project can be accepted or rejected based on other factors.
## Footnote
Acceptance depends on the alignment with the company's investment criteria.
112
What does it mean if the IRR is higher than the company's desired rate of return?
The project may be acceptable.
## Footnote
This indicates potential profitability.
113
What does it mean if the IRR is lower than the company's desired rate of return?
The project would most likely be rejected.
## Footnote
This suggests that the investment may not meet the company's financial goals.
114
Why has IRR become increasingly popular?
Due to the availability of business calculators and computer software.
## Footnote
These tools simplify complex calculations involved in determining IRR.
115
What relationships do PV, NPV, and IRR share?
They all use discounting to assess the relationship between future value and present value.
## Footnote
Each equation generally involves the same variables.
116
What can rearranging the variables in the equations provide?
Important information on the viability of proposed investments.
## Footnote
This allows for analysis of different financial scenarios.
117
What is the formula for Present Value (PV)?
PV = cash flows + terminal value + discount rate + initial investment
## Footnote
PV is used to determine the current worth of future cash flows.
118
What does Net Present Value (NPV) consider?
NPV considers cash flows, terminal value, discount rate, and initial investment
## Footnote
NPV is used to assess the profitability of an investment.
119
What factors are included in calculating Internal Rate of Return (IRR)?
IRR includes cash flows, terminal value, and initial investment
## Footnote
IRR is the interest rate at which the NPV of an investment is zero.
120
When is it best to use the Present Value equation?
When the initial value is unknown
## Footnote
PV is particularly useful in scenarios where future cash flows need to be evaluated.
121
When should you not use the NPV equation?
When the initial value is known, initial investments are dissimilar, or discount rate is unknown
## Footnote
These conditions can lead to inaccurate evaluations using NPV.
122
What are the known elements in calculating IRR?
Original investment, periodic benefits, terminal value, discount rate
## Footnote
These elements are necessary to solve for the IRR.
123
What is a situation that suits the NPV equation best?
When the initial value is known
## Footnote
This helps in accurately determining the potential profitability of an investment.
124
Fill in the blank: The original investment is a __________ element in calculating NPV.
known
## Footnote
Recognizing known versus unknown elements is critical in financial evaluations.
125
True or False: The discount rate is always known when using the NPV equation.
False
## Footnote
An unknown discount rate can complicate the NPV calculation.
126
What is the purpose of breaking even analysis?
To determine the point when income just covers expenses
## Footnote
This analysis helps businesses understand their minimum performance requirements.
127
What is break-even analysis?
A technique for determining the point when income just covers all expenses, including debt service.
128
What question does break-even analysis answer?
At what occupancy level will the building cover all costs associated with it?
129
What does the break-even point indicate for a property company?
The financial goals a property company must meet to become profitable.
130
How can break-even analysis be applied in real estate?
To determine how much space must be leased to cover all costs.
131
Give an example of how a hotel uses break-even analysis.
To calculate the number of rooms that must be rented each night to cover costs.
132
How can a shopping mall utilize break-even analysis?
To determine the number of square feet that must be leased to cover costs.
133
How does break-even analysis help evaluate risk for an investor?
If the break-even occupancy rate is close to or higher than expected occupancy, profit generation is unlikely.
134
What part of the management fee can break-even analysis determine?
A percentage of the amount generated by the property beyond the break-even point.
135
What is the formula to calculate the break-even rate?
break-even rate = (operating expenses + annual debt service) / gross possible income.
136
What does the break-even rate equal?
Operating expenses and annual debt service divided by gross possible income.
137
In real estate, what is usually considered the break-even rate?
The occupancy rate.
138
In other industries, what could the break-even rate represent?
Number of products sold, meals served, or hours billed by a consulting group.
139
Fill in the blank: The break-even rate can be calculated using the formula: break-even rate x gross possible income = _______.
operating expenses + annual debt service
140
What is gross possible income in the context of break-even analysis?
The total income possible at 100 percent occupancy at market rates.
141
What is the formula for calculating break-even rate?
break-even rate = (operating expenses + annual debt service + equity return) / gross possible income
## Footnote
This formula reflects the total financial obligations against potential income.
142
What is the gross possible income calculation for 150 apartments at $1,200 per month?
$2,160,000
## Footnote
Calculation: 150 apartments × $1,200 × 12 months.
143
What is the break-even rate when the total operating expenses are $850,000 and annual debt service is $960,000?
83.8%
## Footnote
Calculation: break-even rate = ($850,000 + $960,000) / $2,160,000.
144
If the owner requires a cash flow of $50,000 a year, what does the break-even rate increase to?
86.1%
## Footnote
Calculation: break-even rate = ($850,000 + $960,000 + $50,000) / $2,160,000.
145
True or False: An occupancy rate of 83.8% is considered possible.
True
## Footnote
This indicates a feasible occupancy level for the property.
146
What must be done if the owner needs more cash flow?
Rent more units
## Footnote
More units must be rented to distribute additional income to the owner.
147
What are two ways of evaluating performance mentioned?
Two ratios that indicate a project's financial viability
## Footnote
Specific ratios are not detailed in the provided text.
148
What are two ways of evaluating performance in financial projects?
Return on investment and payback period
## Footnote
These ratios help assess a project's financial viability.
149
How is Return on Investment (ROI) calculated?
ROI = NOI ÷ total capital invested
## Footnote
NOI stands for net operating income.
150
If the net operating income (NOI) is $144,000 and the total capital invested is $1.75 million, what is the ROI?
8.2%
## Footnote
ROI calculation: 144,000 ÷ 1,750,000 = 0.082 or 8.2%.
151
What is the formula for calculating the payback period?
payback period = initial investment ÷ annual cash flow
## Footnote
Annual cash flow is calculated by subtracting debt service from NOI.
152
How do you calculate annual cash flow if NOI is $165,000 and debt service is $65,000?
annual cash flow = NOI - debt service = 100,000
## Footnote
Calculation: 165,000 - 65,000 = 100,000.
153
If an initial investment is $800,000 and the annual cash flow is $100,000, what is the payback period?
8 years
## Footnote
Payback period calculation: 800,000 ÷ 100,000 = 8.
154
True or False: ROI is a measure of how much profit is made relative to the total investment.
True
## Footnote
ROI indicates the profitability of an investment.
155
Fill in the blank: The payback period measures the time required for an investment to _______.
pay back its initial investment
## Footnote
It assesses how quickly an investment can generate enough cash flow.
156
What does ROI stand for?
Return on Investment
## Footnote
ROI is a measure used to evaluate the efficiency of an investment.
157
What is a key advantage of ROI in real estate management?
Encourages efficient use of funds
## Footnote
By raising the NOI and lessening capital investment, ROI increases.
158
What is a disadvantage of using ROI as a performance measure?
Encourages a short-term mentality
## Footnote
Critics argue that ROI may lead decision-makers to focus on short-term gains.
159
What does the payback period measure?
Time to recover investment costs
## Footnote
It indicates how long it will take for an investment to recoup its initial costs.
160
What is the main advantage of the payback period?
Provides a sense of cost recovery duration
## Footnote
Important for decision-making in real estate due to long asset holding periods.
161
What is a disadvantage of the payback period?
Does not account for the time value of money
## Footnote
This limits its effectiveness as a financial performance measure.
162
True or False: ROI and payback period consider the time value of money.
False
## Footnote
Both measures are considered rougher than PV, NPV, and IRR because they ignore the time value of money.
163
Fill in the blank: The main advantage of _______ is that it gives a sense of how long it will take for an investment to recover its costs.
payback period
## Footnote
This is particularly relevant in long-term asset management.
164
What should you do after completing Activities 1 through 4 in the Workbook?
Check your answers in the Activity Answer section
## Footnote
This ensures you understand the material covered in Lesson 2.
165
What are the three kinds of accounting commonly in use?
1. Financial accounting
2. Managerial accounting
3. Tax accounting
## Footnote
Each type serves different purposes and audiences.
166
Why is good record keeping important to managerial decision making and planning?
It ensures accurate data is available for analysis and facilitates informed decisions.
## Footnote
Good records help in tracking performance and forecasting future trends.
167
Why is a free flow of information within an organization helpful in budgeting and planning?
It promotes collaboration and ensures that all departments are aligned with financial goals.
## Footnote
Open communication can lead to better resource allocation and strategic planning.
168
What is the difference between compounding and discounting?
Compounding involves calculating future values from present values, while discounting involves calculating present values from future values.
## Footnote
Both are essential in time value of money calculations.
169
What is future value?
The amount of money an investment will grow to over a period at a given interest rate.
## Footnote
Future value calculations consider the effects of compounding.
170
What is present value?
The current worth of a future sum of money or stream of cash flows, discounted at a specific interest rate.
## Footnote
Present value calculations are crucial for evaluating investment opportunities.
171
Are future value and present value related?
Yes, they are inversely related; knowing one allows calculation of the other through discounting or compounding.
## Footnote
This relationship is key in financial analysis.
172
What effect does an NPV greater than zero have on investment decision making?
It indicates that the investment is expected to generate profit beyond the cost of capital.
## Footnote
A positive NPV suggests proceeding with the investment.
173
What does it mean if the NPV is equal to zero or less than zero?
NPV equal to zero indicates break-even; less than zero suggests a loss and discourages investment.
## Footnote
NPV is a critical measure in investment appraisal.
174
Why is discounting important in present value, NPV, and IRR calculations?
It reflects the time value of money, recognizing that cash flows in the future are worth less than cash flows today.
## Footnote
Discounting allows for a more accurate assessment of investment value.
175
What does the ROI equation relate to?
It relates to the return on investment, measuring the gain or loss generated relative to the investment cost.
## Footnote
ROI is a key performance indicator in financial analysis.
176
What is the main advantage of calculating the payback period of an investment?
It provides a simple measure of how quickly an investment can return its initial cost.
## Footnote
A shorter payback period is generally preferred as it indicates faster recovery of funds.
177
What are the three kinds of accounting?
Cash basis, accrual basis, modified accrual basis
178
In cash-basis accounting, when are revenues declared?
When cash is received
179
In accrual-basis accounting, when are revenues declared?
In the accounting period in which they are earned
180
What is the purpose of accurate records in accounting?
To provide a complete picture of transactions, predict future revenues and expenses, and analyze budgeted vs actual amounts
181
Why is it important for business managers to understand the financial impact of their decisions?
To evaluate financial performance and make informed decisions
182
Who often has ideas to cut costs and enhance productivity in a company?
People who work closest to a situation
183
What does compounding refer to?
Finding the value of a dollar amount at some point in the future
184
What does discounting refer to?
Finding the value in present dollars of a future amount
185
What is future value?
How much an investment will be worth after a certain period at a certain rate of interest
186
What is present value?
Calculating how much money must be set aside at a certain rate of interest for future use
187
If the NPV is greater than zero, what does it indicate?
The investment's yield exceeds the desired rate of return
188
What does it mean if the NPV is equal to zero?
The investment's yield is equal to the desired rate of return
189
What does it indicate if the NPV is less than zero?
The investment is not acceptable at the chosen rate of return
190
What do ratios and equations including discounting take into account?
The time value of money
191
Fill in the blank: In cash-basis accounting, expenses are declared when cash is _______.
Paid out
192
Fill in the blank: In accrual-basis accounting, expenses are declared in the accounting period in which the expense is _______.
Incurred
193
True or False: In accounting, complete and accurate records can be used as a sound basis for comparison.
True
194
What is break-even analysis?
A technique for determining the point when sales just cover all costs.
195
What does the break-even point indicate?
It indicates what occupancy goals a property must set to become profitable.
196
What does ROI stand for?
Return on Investment.
197
How is ROI calculated?
ROI = NOI ÷ total capital invested.
198
What does NOI stand for?
Net Operating Income.
199
What does the ROI percentage represent?
It serves as a gauge of the yearly performance of an investment.
200
What is the main advantage of the payback period?
It provides a sense of how long it will take for an investment to recover the cash invested.
