Chapter 17

As KeyCorp’s executives discovered, harnessing the power of information technology gives a company a significant competitive advantage. The data warehouse helped KeyCorp cut costs, increase profits, spot market trends faster, and communicate more effectively with customers. It also showed the bank where to invest more marketing dollars to build stronger customer relationships.

Information systems like KeyCorp’s data warehouse and the computers that comprise them are so much a part of our lives that we almost take them for granted. In less than 60 years, we have shifted from an industrial society to a knowledge-based economy driven by information. Businesses depend on information technology for everything from running daily operations to making strategic decisions. Computers are the tools of this information age, performing extremely complex operations as well as everyday jobs like word processing and creating spreadsheets. Through networks of linked computers, one manager can share information with hundreds of thousands of people around the world almost as easily as with a colleague on another floor of the same office building.

Many companies now have a chief information officer (CIO), an executive with responsibility for managing all information resources.

Because most jobs today depend on managing information—obtaining, using, creating, and sharing it—this chapter begins with the role of information in decision-making and the relationship between computers and information systems. Next it describes computer hardware, computer software, and computer networks. The following sections discuss business information systems and the management of information technology. Finally, we’ll look at the latest trends in information technology. Throughout this chapter, examples show how managers and their companies are using computers to make better decisions in a highly competitive world.

Information technology (IT), the equipment and techniques used to manage and process information, has changed the way people make decisions today. Only 30 years ago, well within the careers of many of today’s top executives, few companies used computers. Today, IT is one of the fastest growing industries and includes not only computers but also telecommunications and Internet-related products and services. Computers now reside on almost every employee desktop and provide vast stores of information for decision making. Some of it is useful and some is not. To be useful, information must be:

making a given decision. For instance, when deciding whether to order raw materials, a manager is more likely to need information about inventories and future production plans than about overtime pay.

Managers use information systems (ISs), methods and equipment that provide information about all aspects of a firm’s operations, to get the information they need to make decisions.

One function of an information system is to gather data, the many facts that together describe the company’s status. For instance, the fact that a worker finished a unit of production on job 23-M-8735 at 2:17 P.M. on March 7 is a data item. When a manager must make a decision, a long list of data is generally not useful.

For the production supervisor, a list of the times during the past hour when each unit was completed is far too detailed. Data must be turned into information, a meaningful and useful summary of data. The total number of units produced in the hour would be useful information.

Businesses collect a great deal of data. Only through well-designed IT systems and the power of computers can managers use such data to make better decisions. Companies are discovering that they can’t operate well with a series of separate information systems geared to solving specific departmental problems. They need to integrate the systems throughout the firm. Company-wide systems that bring together human resources, operations, and technology are becoming an integral part of business strategy.

Technology experts are learning more about the way the business operates, and business managers are learning to use technology efficiently to create new opportunities. Once companies know where they want to go, information systems can help them reach those goals.

…Computers have become a common feature of our lives today. Only rarely do we buy something or transact business without using computers in some way: scanning prices at a checkout, verifying a credit card through a network, getting cash from an ATM, using a spreadsheet to determine how much bank financing a company needs, or using a word processor to prepare a contract. Computers are essential to business operations, where they have greatly improved the quality, quantity, and accessibility of management information. They are part of the home scene as well. About 50 percent of all homes in the United States now have computers. In addition, many devices we use daily, from VCRs and microwave ovens to automobiles, contain miniature computers.

As useful as computers are, however, it’s important to remember that a computer is just a machine that stores and manipulates symbols based on a set of instructions. It can’t decide what information is needed to make a decision. Nor can it make the kinds of judgments that managers are expected to make. Nevertheless, computers have major advantages, including processing speed and accuracy and the ability to store vast amounts of data and programs. Because computers can process data millions of times faster than the human brain, they make it possible to manipulate and organize enormous amounts of data. Then managers access the information and make decisions. Of course, computers are only as good as the data put into them and the instructions they are given. They cannot distinguish between right and wrong data. Let’s now take a closer look at computer systems and the main types of computers.

Modern information systems combine computers, printers, terminals and displays, and many other hardware parts. Hardware is the equipment associated with the computer system. The list of hardware components can seem endless, but as shown in Exhibit 17-1, page 505, there are really only a few main categories: the input system, the central processing unit with primary storage, secondary storage, and the output system.

To be useful, computers must be able to receive data to process from an input system. Most data are entered into the computer using the keyboard and a mouse. Scanners are another type of input device. Optical scanners read text and bar codes, which magnetic scanners read routing and account codes on bank checks. Other types of automatic data entry devices include touch-screen display systems used in fast-food restaurants and point-of-sale terminals used in department stores. Voice recognition software is one of the newest forms of input.

The brain of a computer system, the central processing unit (CPU), performs all calculations, interprets program instructions, remembers information, and tells other parts of the computer what to do. The microprocessor chips that comprise the CPU—for example, Intel’s Pentium series and the Macintosh PowerPC—determine the computer’s basic characteristics.

The primary storage provides temporary storage for the instructions and data that the computer is processing.

The primary type of memory in the CPU is random access memory (RAM), active, short-term memory that stores data and instructions for manipulating the data. These data are lost when the computer is turned off. The computer can quickly access any part of RAM.

Because primary storage is limited in amount and is only temporary, computers need a secondary storage system for long-term storage of programs and data. Secondary storage typically uses a combination of hard disk drives and other devices such as floppy disk drives, CD-ROM drives, tape drives, and Zip drives.

The main output devices are video display screen (monitor) and the printer. The display screen shows both text and graphics on a television-like screen. The printer creates hard copy of the output, usually on paper. Printers vary in cost, speed, and quality of output with quality like typesetting. Inkjet printers are a lower-cost alternative that have improved in quality. Some offer color as well as black and white printing.

Most experts divide today’s computers into four categories by size: microcomputers, minicomputers, mainframe computers, and supercomputers.

Often called personal computers (PCs) or desktop computers. Microcomputers are the most widely used type of computer. Their small size, increasing ease of use and power, and flexibility have enabled everyone, not just technology specialists, to enjoy the benefits of computers. Today most businesses and about 50 percent of all homes have PCs. Some PCs are single-user systems, while others are powerful enough to handle several users at the same time. Smaller, portable microcomputers are among the fastest growing segments of the microcomputer market.

Laptop or notebook computers are portable units that rival desktops in computing power—yet can weigh just a few pounds.

Smaller yet are handheld or notepad computers, some of which can read handwritten characters.

Too large to fit on a desktop but small enough to fit in an office, minicomputers are medium-sized computers often housed in one or two cabinets about the size of a file cabinet. The offer greater processing speed than microcomputers. the lines between minis and other types of computers is blurring, however, Many of today’s minis would have been classified as mainframes five years ago.

Minis are often at the heart of a company’s computer network, which links together computers and related equipment such as printers so that employees can share data. They are also used in Internet networks. (Networks are discussed in greater detail in a later section of the chapter.)

Mainframe computers have much greater storage capacity than PCs or mini computers and can serve many users at the same time. Several units can be linked together to work as one unit to increase computing power. Other advantages include security and reliability. Today’s mainframes are sleek, refrigerator-sized computers that cost far less to operate than their room-sized predecessors. They continue to be a major workhorse for companies with heavy data processing loads. About 70 percent of all corporate data resides on mainframe computers. Like microcomputers, they are used for networking.

There is much more to the mainframe computer than its raw computing power. A mainframe computer is specially designed to efficiently handle very high volumes of data and manage vast amounts of stored information. Firms typically use mainframes to store and retrieve data that are directly used by employees across the company; the mainframe allows them to access data simultaneously.

In a large manufacturing company, for instance, people need to share information about inventories, customers, accounts, and production schedules. All that information can be stored in a central mainframe computer, which can run many large programs at once, handle heavy transaction volumes, and provide very rapid responses to requests. These capabilities make mainframes ideal for use in networks….

The most powerful computers, supercomputers are used to do complex computations to simulate or predict difficult problems. They can perform many interrelated calculations quickly. Their size has ranged between minicomputers and mainframe computers, but the most recent models are only slightly larger than the typical microcomputer. Because the processors that make up a supercomputer can be linked together to share memory, these machines now have a processing speed of 3.1 teraflops—3.1 trillion calculations per second—and could reach 100 teraflops by 2004.

Once reserved for scientific analysis such as nuclear physics and mapping genes, supercomputers are now being used to solve government and business problems as well. For example, the Blue Mountain supercomputer at Los Alamos performs simulations to help cities manage traffic congestion and pollution, drug companies speed up new drug research, and automobile manufacturers design safer cars. Motorola uses the University of Illinois supercomputers to map cell phone systems in metropolitan areas. Computations that took months now take only hours.

Computers have greatly increased worker productivity and efficiency at both large and small companies. For example, DaimlerChrysler uses powerful computers to conduct crash simulations, structural analysis, and other tests to improve auto safety and design. Compared to traditional crash testing, each virtual crash saves the company about $275,000.

Companies now use computers for thousands of activities. The set of instructions that directs the computer’s activities is called software. Some software is very complex and handles major information processing tasks for finance, accounting, production, sales, and marketing functions. Often companies customize their software to meet the needs of their particular industry. Software falls into two main categories: systems software and applications software.

Systems software controls the computer and provides program routines that enable applications programs to run on a particular computer.

These program routines are part of an operating system, a collection of programs that manage the computer’s activities and run applications software. Commonly used operating systems include MS-DOS (Microsoft Disk Operating System), Windows (which makes MS-DOS easier to use by adding a graphical user interface), IBM’s OS/2, Apple’s Macintosh system, UNIX, and LINUX.

Applications software is applied to a real-world task. It is used to perform a specific particular task or to solve a particular problem. If clerks need to record customer orders, they use an order-entry application program. If service representatives need to type letters in response to customer inquiries, they use a word processing application program. Applications software covers a wide range of programs, from the complex software that handles the large-scale processing needs of businesses to PC productivity software used by both businesses and individuals to games and other types of entertainment software.

Sabrina Tam, a sales representative for Homestyle Corp., a large furniture maker, provides a good example of how applications software is used. To help her better serve her customers, Homestyle has given Sabrina a powerful laptop computer with color display screen, communications modem, and CD-ROM drive that she can carry into a store owner’s office and use during her presentations. Her laptop has word processing, spreadsheet, database management, graphics, and communication software. Sabrina can also use the modem to connect Homestyle’s central computers to find current product prices, check merchandise availability, and enter customers’ orders while in their offices.

Sabrina uses word processing software to write, edit, and format letters to customers and reports to her manager. Special checkers verify both the spelling and grammar in her documents. Her word processing program makes it easy to change documents without having to retype them. Sabrina can personalize letters to her customers by changing type styles and sizes, inserting graphics, and using various other features. Many word processing programs include features that enable Sabrina to design a simple newsletter for her customers and create documents for display on her company’s Web site. Widely used word processing programs include Microsoft Word and Word Perfect.

Sabrina uses spreadsheet software to prepare sales and expense records for her manager, price estimates and bids for customers, and other materials involving rows and columns of numbers. Spreadsheet software automatically calculates the rows and columns. Once the mathematical formulas are keyed into the spreadsheet, the data can be changed, and the solution will be recalculated instantaneously. Spreadsheets have many uses, including preparation and analysis of financial statements, sales forecasts, and budgets.

Like electronic filing cabinets, database software records, updates, and stores information. Sabrina uses database management software to keep records on the 473 customers in her territory. She puts basic information on each customer into the database, including store name, address, name of owner or manager, telephone number, fax number, email address, date of most recent call, furniture lines carried, and yearly volume of purchases. The records also include notes from previous sales calls, information on each customer’s special needs, and a list of past purchases. The entries in each customer file form a record. Within each record are several columns, or fields; each contains a single piece of information about that customer—the store name, street address, city, and so on.

With this electronic research tool, Sabrina can search through data on her customers, sorting and organizing records in her customer database in many ways to more efficiently cover her territory. For instance, she can list customers in order of their most recent visit and value of last year’s furniture purchases. This information would help her focus on high-volume customers she has not visited recently. When new products are introduced, she can group customers by ZIP code, sort them by volume of purchases, and schedule her visits to the best prospects on a region-by-region basis. Widely used database software includes Microsoft Access and FileMaker Pro.

Sabrina uses graphics software to create tables and graphs for customer presentations and reports. She can summarize complex information in a visual rather than text form to make it more easily understood. For instance, she can depict a customer’s profits from sales of her line of furniture. She can show profits for last year and then use similar graphs to show the potential profits from orders this year.

Her graphics package, called presentation graphics software, is the simplest type. Yet the graphs it produces are more detailed than those produced by other types of programs. Sabrina can also use the graphics feature of her spreadsheet or word processing programs to illustrate her projections. Exhibit 17-3, page 511, is a bar graph of current verses projected sales for each product line. Widely used graphics systems include Adobe Illustrator and Freehand and Coral Draw.

Specialized programs such as Microsoft PowerPoint simplify the task of preparing presentations slides. They include tools to create charts, graphs, and pictures. The latest versions of presentation software include such features as multimedia and animation to enhance presentations.

Homestyle uses desktop publishing software to design and produce sales brochures, catalogs, advertisements, and newsletters. This software combines word processing, graphics, and page layout software to create documents. Sabrina can design her newsletter with multiple columns of text on a page along with titles, pictures, and graphs. For mailings to her customers, Sabrina sometimes uses her word processor to prepare text and a graphics program to make a very handsome mailing piece. The company saves both time and money by not sending materials out to typesetters and other specialists. Widely used desktop publishing programs include PageMaker, QuarkXPress, and Microsoft Publisher.

Sabrina uses her computer’s modem, communications software, and a telephone link to transfer customer orders, sales reports, expense reports, and other information to and from the home office.

The modem translates data into a form that can be transmitted. Sabrina can call up her company’s central computer system (which also has a modem and communications software) and transfer data. Systems like this are often used to connect microcomputers to larger company computers.

Instead of using individual programs to perform each of the tasks described above, Sabrina could use an integrated software package or a software suite that combines several popular types of programs. The component programs are designed to work together, making it easy to switch between word processing and graphics, for example, and to import a picture or chart from one module to another. Integrated software packages like Microsoft Works and ClarisWorks include word processing, spreadsheet, database, graphics, and communications programs. Although integrated applications are scaled down versions of the individual programs, they have the features most users need and cost considerably less than buying separate software.

Software suites such as Microsoft Office, Claris Works, and Lotus Smart Suite bundle together full versions of compatible applications at a reduced price. Like integrated software, suites typically include word processing, spreadsheet, database management, graphics presentation, and communication programs. The latest versions of suites now allow users to format documents for publication on Web pages.

Today most businesses use networks to deliver information to employees, suppliers, and customers. A computer network is a group of two or more computer systems linked together by communications channels to share data and information. Networks have been widely used for about 20 years, but microcomputers have made networking much more affordable and popular. Whereas early networks could connect about 20 users and share only data, today’s networks link thousands of users and can transmit audio and video as well as data.

By making it easy and fast to share information, networks have created new ways to work and increase productivity. They provide more efficient use of resources, permitting communication and collaboration across distance and time. With file sharing, all employees, regardless of location, have access to the same information. Shared databases also eliminate duplication of effort. Employees at different sites can “screen share” computer files, working on data as if they were in the same room. Their computers are connected by phone lines, they all see the same thing on their display, and anyone can make changes that are seen by the other participants. The employees can also use the networks for videoconferencing.

Networks make it possible for companies to run enterprise software, large programs with integrated modules that manage all of the corporation’s internal operations. Enterprise resource planning (ERP) systems (first described in Chapter 12) run on networks. Typical subsystems include finance, human resources, engineering, sales and order distribution, and procurement. These modules work independently and then automatically exchange information, creating a company-wide system that includes current delivery dates, inventory status, quality control, and other critical information. ERP applications can also be integrated with Web-based resources, as we’ll see in Chapter 18. Let’s now look at two basic types of networks companies use to transmit data: local area networks and wide area networks.

A local area network (LAN) lets people at one site exchange data and share the use of hardware and software from a variety of computer manufacturers. LANs offer companies a more cost-effective way to link computers than linking terminals to a mainframe computer. The most common uses of LANs at small businesses, for example, are office automation, accounting, and information management.

LANs can help companies reduce staff, streamline operations, and cut processing costs. United Science Industries, a fast-growing general contractor in Woodlawn, Illinois, invested $76,000 in a LAN with 15 networked computers. Instead of using field managers’ handwritten sheets to produce invoices, the accounting department can access field manager files through the network. Invoices to out in 10 to 12 days instead of two months, the company collects accounts receivable 5 to 10 days faster, and its monthly labor costs dropped $20,000. “With the network, people spend less time hunting for information and more time working on tasks crucial to operations,” says CEO Jay Koch.

A wide are network (WAN) connects computers at different sites via telecommunications media such as phone lines, satellites, and microwaves. A modem connects the computer or a terminal to the telephone line and transmits data almost instantly, in less than a second. The Internet is essentially a worldwide WAN. Long-distance telephone companies, such as AT&T, MCI WorldCom, and Sprint, operate very large WANs. Companies also connect LANs at various locations into WANs. WANs make it possible for companies to work on critical projects around the clock by using teams in different time zones.

Two forms of WANs—intranets and extranets—use Internet technology. We’ll look at intranets, internal corporate networks, in this chapter and discuss extranets in the following chapter.

Like LANs, intranets are private corporate networks. Many companies use both types of internal networks. However, because they use Internet technology to connect computers, intranets are WANs that link employees in many locations and with different types of computers.

Essentially mini-Internets that serve only the company’s employees, intranets operate behind a firewall that prevents unauthorized access. Employees navigate using a standard Web browser, which makes the intranet easier to use than a client/server system. They are also considerably less expensive to install and maintain and can take advantage of Internet interactive features such as chat rooms and team work spaces.

Until recently, intranets were too complicated and expensive for small businesses, but the cost has dropped as companies develop off-the-shelf programs. Children’s Orchard, a franchiser whose stores sell new, secondhand, and manufacturer’s overstock toys and children’s clothing, uses an intranet to communicate with franchisees around the United States. It is the primary source for company news, corporate services, and peer support. Franchisees have a password to access the intranet through the company’s regular Website. There they can read newsletters, order supplies, and call up statistics on other stores to see how they compare. They can also chat with other franchisees to share ideas and solve problems. CEO Walter Hamilton estimates that the intranet saves the company at least $40,000 a year.

While individuals use business productivity software to accomplish a variety of tasks, the job of managing a company’s information needs falls to information systems: users, hardware, and software that support decision making.

As we learned in Chapter 12, factories use computer-based information systems to automate production processes and order and monitor inventory. Most companies use them to process customers orders and handle billing and vendor payments. Financial service companies like KeyCorp use a variety of information systems to process transactions such as deposits, ATM withdrawals, and loan payments. Most consumer transactions also involve information systems. When you check out at the supermarket, book a hotel room using a toll-free hotel reservations number, or buy CDs over the Internet, information systems record and track the transaction and transmit the data to the necessary places.

of the firm—for example, customer orders, pricing, employee payrolls, and inventory. These operational systems capture and organize raw data and convert these data into information.

that help managers make decisions. These systems allow users to analyze data, including the transaction systems’ operational data, to identify business trends, make forecasts, and model business strategies.

as email, facsimile (fax) machines, and word processing to improve the flow of information throughout an organization. These systems support employees at all levels.

Each type of information system serves a particular level of decision making: operational, tactical, and strategic. Exhibit 17-4 shows the relationship between transaction processing and management support systems as well as the management levels they serve.

Let’s now take a more detailed look at how companies and managers use transaction processing and management support systems to manage information.

The firm’s integrated information system starts with its transaction processing system (TPS). The TPS receives raw data from internal and external sources and prepares these data for storage in a database similar to a microcomputer database but vastly larger. In fact, all the company’s key data are stored in a single huge database that becomes the company’s central information resource.

A database management system tracks the data and allows users to query the data base for the information they need.

The database can be updated in two ways. With batch processing, data are collected over some time period and processed together. Batch processing uses computer resources very efficiently and is well suited to applications such as payroll processing that require periodic rather than continuous processing.

Online, or real-time processing processes data as they become available. When you make an airline reservation, the agent enters your reservation directly into the airline’s computer and quickly receives confirmation. Online processing keeps the company’s data current. Because absolutely current data are needed for management decision making, many large companies use online processing systems.

The transaction processing systems of large companies are custom designed to keep the records they need. But some applications in the areas of accounting and finance, human resource management, sales and marketing, and manufacturing are nearly universal. For example, the accounting information system diagrammed in Exhibit 17-5 is a typical TPS.

It has subsystems for order entry, accounts receivable (for billing customers), accounts payable (for paying bills), payroll, inventory, and general ledger (for determining the financial status and profitability of the business). The accounting information system provides input to and received input from the firm’s other information systems, such as manufacturing (production planning data, for example) and human resources (data on hours worked and salary increases to generate paychecks).

Transaction processing systems were the first stage of information technology. By automating routine and tedious back-office processes such as accounting, order processing, and financial reporting, they reduced clerical expenses and provided basic operational information more quickly. As technology improved, businesses realized that computers could do more than merely process data

Managers now have several types of management support systems (MSSs) that use the internal database to help them make better decisions.

As we saw in the KeyCorp opening vignette, information technology such as data warehousing are part of the more advanced MSSs.

A data warehouse combines many databases across the whole company into one central database that supports management decision making. Data warehouses include software to extract data from operational databases, maintain the data in the warehouse, and provide data to users.

At the first level of a MSS is an information reporting system, which uses summary data collected by the TPS to produce reports with statistics that managers can use to make decisions. Some reports are scheduled and present information on a regular basis. For instance, Homestyle’s payroll personnel get a weekly payroll report showing how each employee’s paycheck was determined. The next level of report summarizes information. A payroll summary report might show higher-level managers total labor cost by department, overtime as a percentage of total payroll cost by department, and a comparison of current labor costs with those in the prior year. Exception reports help identify problems by telling about cases that fail to meet some standard. An accounts receivable exception report that lists all customers with overdue accounts would help collection personnel focus on their work. Demand reports are special reports generated only when a manager requests them. The marketing manager for the Honey Wood furniture line might call for reports on sales by region and type of store to identify reasons for the sales decline.

A decision support system (DSS) helps managers make decisions using computer models that describe real-world process. the DSS also uses data from the internal database but looks for specific data that relate to the problems at hand. It is a tool for answering “what if” questions about what would happen if the manager made certain changes. In simple cases, a manager can create a spreadsheet and try changing some of the numbers. For instance, a manager could create a spreadsheet to show the amount of overtime required if the number of workers increases or decreases. With models, the manager enters into the computer the values that describe a particular situation, and the program computes the results. Homestyle’s marketing executives could run DSS models that use sales data and demographic assumptions to develop forecasts of the types of furniture that would appeal to the fastest growing population groups.

Although similar to a DSS, an executive information system (EIS) is customized for an individual executive. These systems provide specific information for strategic decisions. For example, Homestyle’s CEO has an EIS with special spreadsheets that present financial data comparing Homestyle to its principle competitors and graphs showing current economic and industry trends. Belk, Inc., America’s largest privately held department store company, developed an EIS for its buyers, assistant buyers, and executives. Its easy-to-understand interface allows users to quickly get answers to high-level questions such as, “How did last week’s markdowns affect the sale of intimate apparel compared to the same time last year?” “Will our current inventory for Kenneth Cole shoes at our Charlotte store be sufficient, given the pending promotion?”

An expert system gives managers advice similar to what they would get from a human consultant. Artificial intelligence enables computers to reason and learn to solve problems in much the same way humans do. The use of expert systems is growing as more applications are found. To date, expert systems have been used to help explore for oil, schedule employee work shifts, and diagnose illnesses. Some expert systems take the place of human experts, while others assist them.

Today’s office automation systems make good use of the computer networks in many companies to improve communications. Office automation systems assist all levels of employees and enable managers to handle most of their own communication. The key elements include:

ability to display more extensive written messages sent from a computer network.

Office automation systems also make telecommuting and homebased businesses possible. An estimated 8 million people work at home, using microcomputers and other high-tech equipment to keep in touch with the office. Instead of spending time on the road twice a day, telecommuters work at home two or more days a week. As we discussed in Chapter 6, home offices are a popular trend among small business owners.

With the help of computers, people have produced more data in the last 30 years than in the previous 5,000 years combined. Companies today make sizable investments in information technology to help them manage this overwhelming amount of data, convert the data to knowledge, and deliver it to the people who need it. In many cases, however, the companies to do not reap the benefits from these expenditures. Among the typical complaints from senior executives are that the payoff from IT investments is inadequate, IT investments do not relate to business strategy, the firm seems to be buying the latest technology for technology’s sake, and communications between IT specialists and IT users are poor.

Managing a company’s information resources requires a coordinated effort among a firm’s top executives, IT managers, and business unit managers. The goal is to develop an integrated, company-wide technology plan that achieves a balance between business judgment and technology expertise. Protecting company information and privacy concerns are other important aspects of knowledge management.

Like any other business activity that involves the entire company, IT requires coordinated strategies and planning that take into account the companies strategic objectives. Then managers can select the right technology to help them reach those goals.

The goal of technology planning is to provide employees with the tools they need to perform their jobs at the highest levels of efficiency. The first step is a general needs assessment, followed by ranking of projects and the specific choices of hardware and software. Some basic questions departmental managers and IT specialists should ask when planning technology purchases include:

Once managers identify the products that make business sense, they can choose the best products for the company’s needs. The final step is to evaluate the potential benefits of the technology, in terms of efficiency and effectiveness. This requires developing specific criteria—not only quantitative measures like cost savings and profit improvement, but also qualitative factors such as employee satisfaction. For example, how will the new technology increase revenues? Will it get products to the market faster by shortening the product development cycle or streamlining the production process? Will it save employees time and cut labor costs? What other benchmarks does the company want to achieve? How can prevention strategies guard against information loss?

Plans will change over time in response to company needs. “Basically, business and technology plans become living documents that drive the company forward,” says Cheryl Currid, a technology analyst. The planning process can even be a catalyst for growth, as the Focusing on Small Business box, page 519, demonstrates.

Protecting the information stored in computers is not easy task. With the ever increasing dependence on computers, companies must develop plans to cover power outages, equipment failure, human error, and disasters such as major fires, earthquakes, or floods. Many companies install fault-tolerant computer systems designed to withstand such disasters. Preventing costly problems can be as simple as regularly backing up applications and data. Companies should have systems in place that automatically back up the company’s data every day. In addition, employees should back up their own work regularly.

Disasters are not the only threat to data. A great deal of data, much of it confidential, can easily be tapped or destroyed by anyone who knows about computers.

Firms taking steps to prevent computer crimes, which cost large companies hundreds of thousands of dollars every year. There are several major categories of computer crimes:

company’s systems. For example, employees at Bluebird Systems, a software company in Carlsbad California, kept having unexplained system crashes and network slow-downs. A consultant traced the problem to Bluebird’s network administrator, who was also a Sierra Club member and claimed that he’d asked permission to create and maintain the Sierra Club Web site on a Bluebird server. As the site expanded from a few pages to over 2,000, the heavy traffic affected Bluebird’s network operations. Bluebird’s CEO estimated that the network crashes cost the company several million dollars from lost employee productivity and missed deadlines—not to mention the risk of unauthorized access to the company’s files and research.

confidential new product information and provide it to competitors. Networking links make it easier for someone outside the organization to gain access to a company’s computers. Computer crooks are getting more sophisticated all the time and find new ways to get into ultrasecure sites. For example, a British hacker was able to break into the network of the highly secret Rome Laboratory in New York by using computers in Latvia, Colombia, and Chile. Then he attacked defense and government systems.

To protect data, companies can encode confidential information so only one recipient can decipher it. Special authorization systems can help stop unwanted access from inside or outside. These can be as simple as a password or as sophisticated as finger print or voice identification. Companies can also install intrusion-detection systems to monitor networks for activities that signal the possibility of unauthorized access and document suspicious events. We’ll revisit the issue of protecting confidential data in the next chapter’s Internet discussion.

people who haven’t paid for them is another form of unauthorized use. Piracy takes revenue away from the company that developed the program—usually at great cost. Thus, software firms take piracy seriously and go after the offenders. Many also make special arrangements so that large companies can get multiple copies of programs at a lower cost rather than use illegal copies.

employee in the purchasing department could get into the computer system and delete information on past orders and future inventory needs. The sabotage could severely disrupt production and the accounts payable system. Willful acts to destroy or change the data in computers are hard to prevent. To lessen the damage, companies should back up critical information.

software and can spread to other computer systems, a computer virus can destroy the contents of a computer’s hard drive or damage files. Another form is called a “worm” because it spreads itself automatically from computer to computer. Viruses can hide for weeks or months before starting to damage information. A virus that “infects” one computer or network can be spread to another computer by sharing disks or by downloading infected files over the internet. To protect data from virus damage, software developers have created virus protection programs. This software automatically monitors computers to detect and remove viruses. Program developers make regular updates available to guard against newly created viruses. In addition, experts are becoming more proficient at tracking down virus authors, who are subject to criminal damages.

Firms that take a proactive approach can prevent security and technical problems before they start. Here are some ways to avoid an IT meltdown:

employees to troubleshoot problems in advance rather than just react to them. Act on them before they affect the operation.

professionally to employee concerns. Use email and the Web to minimize phone use for answers to nonurgent questions.

hardware, software, and user details to give help-desk agents the information to assist employees. This speeds up diagnosis of problems and improves management of software licenses and updates.

use “remote diagnostics” to provide automatic updates of applications and services and to allow monitoring and fixing of problems.

information and FAQs (frequently asked questions) for employees so they can solve problems themselves.

skills and learn about new technology. Investing in adequate training now will save considerable time and money later.

The very existence of huge electronic file cabinets full of personal information presents a threat to our personal privacy. Until recently, our financial, medical, tax, and other records were stored in separate computer systems. Computer networks make it easy to pool these data into data warehouses. Companies also sell the information they collect about you from sources like warranty registration cards, credit card records, registration at Web sites, and grocery store discount club cards. Telemarketers can combine data from different sources to create fairly detailed profiles of consumers.

Information technology is a continually evolving field. The fast pace and amount of change, coupled with ITs broad reach, make it especially challenging to isolate industry trends. From the time we write this chapter to the time you read it—as little as six months—new trends will appear and those that seemed important may fade. However, three trends that are reshaping the IT landscape at the beginning of the 21^st century are knowledge management, the emergence of information appliances, and the shortage of qualified IT personnel.

Although companies may have procedures to manage information, they are now tackling the more difficult task of knowledge management (KM). Information management

Information management involves collecting, processing, and condensing information.

Knowledge management, however, focuses on gathering and sharing an organization’s collective knowledge to improve productivity and foster innovation. Some companies are even creating a new position, chief knowledge officer, to head up this effort.

We’ve already seen how companies like KeyCorp and Belk use software tools to comb through company databases seeking information. But better software is not the only answer to KM. Effective KM calls for a cultural change within the company. It’s a whole new way of working and communicating that encourages other departments and employees to share knowledge. This attitude can be difficult to promote among employees who are used to protecting their own turf. KM’s benefits can be significant in terms of both time and money. Chevron Corp.’s individual oil refineries had their own methods to improve efficiency. By mounting a formal effort to collect the best refinery management practices and make them available to all locations, Chevron saved $170 million.

As KM has become an important company objective, the CIO has joined the top management team. No longer is IT an isolated department focused on keeping the company’s computer systems running, managing IT costs, and dealing with IT suppliers. Today the CIO and his or her team are partners in the strategic planning process. IT managers provide inpurt on how to leverage technology to improve business processes, change the business model, and better serve customers.

“Information appliances,” easy-to-use, inexpensive, consumer-oriented products that perform only one or two tasks, may soon replace the PC as our most popular information tool. In addition to simplicity and convenience, many of these appliances use wireless technology to make computing more portable.

These devices run counter to the recent trend to make PCs increasingly complex and powerful. Though businesses many need these PCs, most personal users don’t. “The PC is so general purpose that very few of us use more than 5 percent of its capability,” says former Hewlett-Packard CEO Lewis Platt. And for users who only want to do one thing—access the internet, for example—a PC is more than they need. PCs won’t disappear, however. They will coexist with other alternatives, but will no longer dominate to the degree that they do now.

Fueled by such technological advances as tiny storage devices, efficient micro processors, and wireless networks, information appliances could revolutionize the way we view computers. A wide variety of these devices are already available: palmtop personal digital assistants, hand-held scanners, cell phones that send and receive email, portable music players for music downloaded from the Internet, settop TV boxes that automatically save favorite programs, and Web phones with touch-screen access. Tiny microprocessors with Internet and digital capabilities make existing products “smarter.” For example, fax machines that use the Internet rather than phone lines will save transmission costs.

The good news: the rapidly growing IT industry has led the way among all industries in new job creation. The bad news : there aren’t enough qualified IT personnel to fill those jobs. The Information Technology Association of America estimates that over 840,000 positions—more than half the 1.6 million new jobs created in 2000—are likely to go unfilled. One of every 12 IT jobs in the total U.S. IT workforce of 10 million will be vacant. In fact, IT companies rank the shortage of skilled workers their most significant barrier to growth.

It the shortage of IT talent continues, companies will be hard pressed to keep up with the latest IT developments. According to Commerce Department predictions, information systems analysts, computer engineers, and computer scientists will be the fastest-growing groups in terms of job demand though 2008. Yet the number of new college graduates with computer science degrees or programming skills has dropped in recent years. To attract and retain IT talent, companies are implementing new recruitment programs, partnering with educational institutions, increasing in-house training programs fro individuals with no previous IT skills, and developing programs to improve employee satisfaction.

Computer literacy is no longer a luxury. To succeed in business today, almost everyone must develop technological competence. Whether you have a part-time job in a fast-food restaurant that uses computerized ordering systems or perform financial analyses that guide the future of your own company, you will depend on computers. The more you increase your knowledge of technology, the more valuable you will be as an employee in today’s information-driven businesses. In addition, the shortage of qualified IT personnel opens up new career avenues to those that enjoy working with technology. You can also take steps to protect your privacy.

Whether you are an employee or a business owner, you need to be aware of how technology affects the way your firm operates. New applications can change fundamental company operations and employees’ roles. For example, companies that install ERP systems want individual employees to make more strategic, far-reaching decisions than before. This requires a dramatic shift in employee’s roles and the way they should view their jobs. For example, an accountant’s responsibilities might now include analyzing budgets, not just expenses. A salesperson’s role might expand to include more strategic decision making about customer issues. Your company will see the business benefits sooner if you prepare for these changing roles. A manager should begin teaching employees operational procedures before implementing the new system and help them acquire the necessary analytical skills. As an employee, you can take the initiative to learn as much as possible about the new technology and how it operates.

Acquiring IT skills will also open many career opportunities. If travel interests you, head for Europe, where an estimated 1,000,000 IT jobs are vacant. As a result, IT skills and experience are in demand—and salaries worldwide are climbing.

By understanding how companies collect and use information, you can protect your personal data from being mined. The first step is simply saying no. You can usually get a store’s discounts and products even if you withhold some personal information, explains Beth Givens of the Privacy Rights Clearinghouse in San Diego, “You don’t have to give your name when you get a supermarket card. Safeway says you can register as an anonymous shopper.” Also have your name removed from direct market lists to curb unwanted mail and data exchange.

Next, check your credit report for unfamiliar accounts and monthly charge card statements for fraudulent charges that signal that someone may have stolen your personal information. Then contact the creditors and let them know the information is not accurate. Major credit reporting agencies must correct the information. Finally, contact the major credit reporting agencies, Equifax, Experian, and TransUnion, and forbid prescreening credit rating checks. This puts a stop to unsolicited credit card offers, which can fall into the wrong hands.

When making decisions, managers compare information about the company’s current status to its goals and standards. Some of the information is provided by information systems, which collect and process data.

Hardware components include the central processing unit (CPU), the secondary storage system, the input system, and the output system. The CPU performs all calculations, interprets program instruction, and tells other parts of the computer what to do.

Microcomputers are small enough to fit on a desktop. Minicomputers are too large for a desktop but small enough to fit into a normal office. Mainframe computers are about the size of a refrigerator and can quickly and reliably process high volumes of data. Supercomputers can perform complex computations to simulate or predict difficult problems.

Software falls into two main categories: systems software and applications software. The most commonly used applications software are used for word processing, spreadsheets, graphics, databases, desktop publishing, and communications. World processing systems aid in composing, editing, and formatting documents. Spreadsheets automatically manipulate rows and columns of numbers, making analysis easier. Graphics systems create graphs and drawings. Database systems store and retrieve records and create data presentations. Desktop publishing programs help create professional-looking documents with text and graphics. Communication systems can be used to share data among computer systems. Integrated software packages combing several types of applications software into one program or suite.

Local area networks (LANs) and wide area networks (WANs) are used to link computers so they can share data and expensive hardware. Today companies use networks extensively to improve operating efficiency. Networking techniques like email allow employees to communicate with each other quickly, regardless of their location.

An information system consists of a transaction processing system, management support systems, and an office automation system. The transaction processing system collects and organizes operational data on the firm’s activities. Management support systems help managers make better decisions. They include an information reporting system that provides information based on the data to the managers who need it; decision support systems that use models to assist in answering “what if” types of questions; and expert systems that give managers advice similar to what they would get from a human consultant. Executive information systems are customized to the needs of top management. All employees benefit from office automation systems that facilitate communication by using word processing, email, fax machines, and similar technologies.

To get the most value from information technology (IT), companies must go beyond simply collecting and summarizing information. Technology planning involves evaluating the company’s goals and objectives and using the right technology to reach them. Because companies are more dependent on computers than ever before, they need to protect data and equipment from natural disasters and computer crime such as unauthorized access use and malicious damage. They must also take steps to protect customers’ personal privacy rights.

Knowledge management focuses on sharing an organization’s collective knowledge to improve productivity and foster innovation. The CIO plays a pivotal role in knowledge management. The emergence of simpler information appliances may make the PC a less important information tool. Consumers may prefer these easy-to-use devices to multifunction PCs. The shortage of qualified IT personnel is making it harder for companies to stay current with the latest IT developments.

As traditional retailers like Toys “R” Us learned all too well, taking a wait-and-see attitude with regard to the Internet can be disastrous. First-on-the-scene upstarts like eToys can focus all its attention on providing the best online experience. Toys “R” Us arrived at the internet party nine months late—a delay that in Internet time is equal to several years in traditional retailing. Clearly, the internet has transformed the business landscape in the same way that railroads and automobiles triggered earlier industrial revolutions. The computerization of businesses initiated the first stage of the Information Revolution. Now the Internet is a driving force in the second stage, moving us beyond the individual enterprise to an interconnected economy. In the virtual world of cyberspace, companies transact business without regard to traditional boundaries and constraints.

Fueled by Internet-related businesses, the information technology industry is growing at twice the rate of the economy in general. A whole new industry has sprung up around the Internet, and digital industries now represent about 40 percent of GDP. In addition, the internet has changed the way most businesses operate and has forced companies and even whole industries to change their business models. The Internet creates new opportunities for growth through new products, greater speed to market, and enhanced cost competitiveness.

To succeed in business in the new millennium, you must understand how this relatively new communication and transaction medium is shaping business and society, as well as how to use the Internet to your advantage. We’ll start our exploration of the Information Superhighway with some background on the Internet: how it works, its size, and how people use it. Next we’ll look at the impact of the Internet on business operations and industry dynamics, examine the growth of electronic commerce in both the business-to-business and the business-to-consumer markets, and describe the steps required to launch an e-business. The chapter ends with a look at what lies ahead for the Internet.

Just what is this phenomenon? The Internet represents the convergence of the computer’s high-speed processing power with telecommunications networks’ capability to transmit information around the world almost instantaneously. It is the world’s largest computer network, essentially a worldwide “network of networks.”

All of the commercial and public networks that make up the Internet use transmission control protocol/Internet protocol (TCP/IP), a communications technology that allows different computer platforms to communicate with each other to transfer data.

….the Internet began life in 1969 as ARPAnet, a Defense Department network connecting various types of computers at universities doing military research. It subsequently developed into a larger system of networks for academic and research sites managed by the National Science Foundation (NSF). A major growth spurt began around 1993, when the introduction of browser technology made it easy to access graphics and sound as well as text over the World Wide Web.

The World Wide Web (WWW), a subsystem of the Internet, is an informational retrieval system composed of Web sites.

Each Web site contains a home page, the first document users see when they enter the site.

The sight might also contain other pages with documents at the same or other Web sites.

By April 1995, the Internet was so large that the NSF turned over its backbone—the major long-distance, high-speed, high capacity transmission networks—to a group of commercial carriers. However, no one “owns” the Internet. Each private company operates its own networks.

In addition to network administrators and users, the Internet also includes about several thousand Internet service providers (ISPs), commercial services that connect companies and individuals to the Internet. All these players create a shared resource that becomes more useful as the number of networks expands.

Thanks to browsers, software that allows users to access the Web with a graphical point and click interface, the Web has become the center of Internet activity, with the largest collection of online information in the world. As new technology makes it possible to send audio, video, voice (including telephone calls), 3-D animations, and videoconferencing over the Net, the Web is also becoming a multimedia delivery system.

To users around the world, the Internet operates as a single seamless network enabling them to send and receive text, graphics, movies, and sound files. With TCP/IP, the Internet’s interconnected local and long-distance networks work together, regardless of the underlying hardware or software, to send and receive information. For example, suppose that you type the address of a Web page for a company you re researching and the hit the enter key, Exhibit 18-1, page 536, shows the route that these data might travel from you PC to the Web site’s host computer and back again.

A host computer stores services and data used by other computers on the network.

The message travels across your telephone lines from your computer to a bank of modems at your ISP. Then the request travels along a succession of interconnected national backbones to the network of the ISP that hosts the company’s Web site. These national and international networks are run by network service providers (NSPs), major telecommunications companies that operate the high speed long-distance networks. ISPs interconnect and share information at specific interchange points. Finally, your request reaches the company’s Web server that stores the actual content of the Web site.

Servers are computers that store data and “serve” information to other computers, called clients, upon request. Internet servers run specialized software for different applications, like the World Wide Web, email, and Usenet (newsgroups). Each organization on the Web also has its own server with a unique site, or domain, name. The desired information then makes its way back to you over a similar route.

The Internet’s explosive growth is unparalleled. The number of host computers connected to the Internet grew from 1.3 million in 1993 to over 93 million in July 1999 and continues to increase by about 50 to 60 percent a year. The United States is home to about two-thirds of the world’s host computers. The amount of data being processed over the Internet doubles about every 100 days. The Web itself has grown at an astounding rate. Almost 3 billion Web pages crowd the Web today, compared to a few hundred in 1993.

According to surveys of Internet usage compiled by NUA Internet Surveys, about 378 million people are online worldwide as of September 2000. Of the about 148 million of these Internet users living in the United States, about 95 million (64 percent) are regular Internet users. Although the Net was male dominated for many years, women now represent one of the fastest growing groups. One recent survey found that current Net users are evenly divided between male and female….

Using the Hot Links in each chapter of this book, you’ve discovered the wealth of resources available on the World Wide Web. From the five-day weather forecast for any city in the world to statistics on steel production in Russia to the best-selling CD albums of the week—it’s all on the Web. The most visited Web sites are the ones offering news, travel, entertainment, government, health/medicine, product information, sports, music, and games.

What do people do when they log on to the Internet? Sending email is the most popular activity (88%), followed closely by accessing the Web (85%). Once on the Web, they pursue a variety of interests, summarized in Exhibit 18-2, page 538.

Corporations and business users are also active Web participants. In a recent study of major corporations, 89 percent of the respondents had a Web site. Of those, 56 percent offered customer service and 37 percent allowed visitors to make purchases on line. In addition to purchasing supplies and materials and selling products online, businesses use the Internet’s vast resources to:

Exhibit 18-3, page 539, lists the top five responses of Inc. 500 executives when asked what their company’s Web page helped them to achieve.

The Internet has significantly changed today’s global economic framework. As companies rush to adapt Net technology to different tasks and industries, they promote another wave of technological innovation. In addition, the Internet has taken off in ways that its originators probably never imagined. It’s more than just a communication tool, as first envisioned, or another way to get traditional information.

We’re in the midst of a shift to a new Internet-centered economy. Existing companies must reinvent themselves to take advantage of Internet technology. Old business models no longer apply as the Net changes the rules of doing business. Many established companies waited for the Internet market to develop before moving on line. Confident that their size would allow them to push the entrepreneurial upstarts out of the way, they were surprised to find themselves left in the dust. The Internet moved so quickly that they lost the advantage of being first to the Amazon.coms, Yahoo!s, and eToys. Let’s now consider how the Internet affects competition, channel relationships, and marketing.

The Internet is redefining the nature of competition by blurring the traditional barriers of geography and time. Store location and hours were once key factors in attracting customers. Your competition was located within easy driving distance. Now the competitive universe is unlimited. It doesn’t matter whether a company us physically located in Portland, Oregon, or Portland, Maine. On the Web, competitors are just a click away.

In addition, new Internet businesses encounter fewer barriers than traditional businesses when entering a new market. To expand geographically or add new products, traditional retailers must incur substantial costs for a physical store front and distribution. Once a company has a Web site, the cost to acquire a customer in New York is the same as adding one in New Zealand. And online companies find it easier to enter new markets. Amazon.com started with books but now offers CDs, videos, and gifts. In its quest to become a one-stop online transaction company, Amazon developed online retailers such as Pets.com and Homegrocer.com.

The Internet is changing relationships among all channel members; manufacturers, distributors, retailers/service providers, and customers. No longer do companies have to rely on intermediaries to connect with other participants in the supply chain. They can go directly to customers, bypassing traditional channels and displacing some intermediaries.

Take the travel industry, for example, which accounted for over $12 billion of consumer spending in 2000. Travel agents are becoming less important as cybertravelers can now access much of the same information on the Web. Travelers can easily check airplane schedules, find the lowest fares and room prices, view panoramic photos of hotel rooms, obtain maps showing the best route between cities, get advice from experienced travelers in discussion groups, and then make their own reservations. The percentage of airline tickets sold by agents is dropping rapidly as more travelers buy tickets over the web….

Manufacturers with strong brands can also sell directly on the Web. Dell Computer’s Internet sales now amount to more than $40 million a day. To the dismay of wholesalers and traditional retailers like Sears, Levi Strauss has begun selling direct. Iomega, which makes the popular Zip and Jaz hard drives, and Polaroid started selling directly to consumers in spring 1999. Manufacturers with brands carrying more weight than the retailer’s—Estee Lauder and Tommy Hilfiger are two—may be able to bypass retailers entirely….

Distributors are using their customers’ move to the Web to their advantage. They are providing warehousing, logistics, and e-commerce services to retailers and manufacturers. Distributors offer economies of scale to small retailers that want to set up Web shops. A new category of virtual merchant is emerging. Buy.com, for example, outsources order fulfillment and focuses only on selling products at extremely low prices to customers. Merisel, a leading computer products distributor, expects the Internet to make distributors more important to retail customers because they will take on a larger share of retailers’ expenses.

In some industries, going direct takes on additional meaning. Customers no longer have to wait to get boxed software from many developers. They can download programs directly from a Web site, using a special password to unlock the software for their use. New technology to deliver music over the Web is changing the dynamics of the music industry.

The radical shift in bargaining power from sellers to buyers is probably the most fundamental development being shaped by electronic commerce. As John Hagel III, author of Net Gain and Net Worth, says, “Information has been the key driver of negotiating power in economics for a long time, and electronic commerce is giving information to the customer, which in turn will dramatically enhance their bargaining power as they deal with vendors.” All customers, from corporate purchasing agents to individuals, can search sites of various providers to compare products and prices. They can find the best products for their needs, rather than simply accepting what retailers offer. Vendors have a huge opportunity to build relationships by providing assistance in finding the right goods and services.

The availability of neutral sources of product information gives customers greater freedom of choice and control. For example, about 45 percent of car buyers use the Web to shop for their cars, gathering information on dealer costs, options, and financing plans. They arrive at the dealership armed with the facts and ready to drive a hard bargain.

New types of “infomediaries” make it even easier for buyers by pulling together product information from many vendors.

Thanks to intelligent agents that scour the Web’s many databases, consumers no longer have to go from site to site to compare prices and obtain information. For example, CompareNet offers product reviews and online discussion forums as well as price and feature comparisons for a wide range of products.

Portals are also becoming popular. These Web sites gather many resources into one convenient gateway to the Web. Some like Yahoo! are general portholes with links to popular destination sites. Specialized portholes like Intuit’s financial services site also compete for viewer attention.

Service industries are also noticing a change in consumer buying patterns. In financial services, for example, customers can now comparison shop in a way never before possible for financial products such as personal loans, mortgages, auto insurance, and credit cards. Online banking services and stock brokerage attract more users daily. We’ll discuss the Internet’s impactr on financial institutions and markets in Chapters 20 and 22.

Keep these fundamental changes in mind as we now look at how companies in different industries are using e-commerce strategies.

The entire process of selling a product or service via the Internet is called electronic commerce (e-commerce) or electronic business (e-business). E-commerce goes beyond selling products through an electronic catalog, however. Among the benefits Web’s interactivity are convenience and increased efficiency, better customer service, lower transaction costs, and new relationship-building strategies.

E-commerce is moving into the business mainstream. More and more corporate and individual purchasers now go first to the Web to buy products ranging from diesel engine parts to consulting services to baby clothes. Although e-commerce barely existed in 1995, at least half of U.S. companies are selling online, and about 80% are purchasing online. Companies with an online presence are rewarded with growing revenues. According to Forrester Research, consumer e-commerce revenues went from zero to $111 billion in just five years—and are expected to reach $1.3 trillion by 2003. (Like the number of Internet users, the size of the e-commerce market is hard to estimate due to the different criteria used by various research firms.) In a recent survey, 85 percent of CEOs said e-commerce is vital to their company’s future success.

E-commerce includes two distinct market segments. Business-to-business e-commerce involves transactions between companies—for example, purchasing raw materials to manufacture products or supplies.

Business to consumer e-commerce, also called “e-tailing,” involves transactions between businesses and the end user of the goods or services. Although the consumer market has received more media attention, revenue from U.S. e-commerce between businesses accounted for $336 billion (about 25 percent of all e-commerce revenue) in 2000 and is expected to reach $6.3 trillion by 2005. In each of these sectors, companies have several business models from which to choose.

In the early days of e-commerce, companies could choose from three basic e-commerce revenue models:

Travelocity are two examples of business-to-consumer sales sites. Cisco Systems sells about 75 percent of its computer networking products from its Web site. At the other end of the spectrum are niche businesses like Fridgedoor.com, which sells decorative refrigerator magnets.

of the more successful paid news sites. Some online gaming sites charge players to play certain types of games. Travelers can now check e-mail or surf the Web using Internet kiosks located in airports on a pay-as-you-go basis.

Yahoo! and Excite are examples of advertiser-supported sites that provide information to visitors. High-traffic sites, like Netscape’s Netcenter, earn substantial revenue from ad sales. Other sites earn fees by referring customers to merchant sites. CDNow has a corporate affiliate program that pays commissions when visitors order music from CDNow through special links on the affiliate site.

With the vast amount of free information on the Internet, the subscription model has not proved successful in most cases. Already new types of business are emerging that use the Web to create more efficient marketplaces, especially in the business-to-business sector:

Examples of online auctions include eBay, the leading person-to-person auction site; OnSale, a merchant-to-buyer auction service; and Freemarkets, a business-to-business auction service for qualified buyers of industrial materials and components.

operations. The e-service market—from consultants to technology outsourcing companies—is poised for growth, from $22 billion in 1999 to a projected $220 billion by 2003. Services are driving revenue growth at IBM. On a smaller scale, Wazzu Corp. offers turnkey Internet solutions for small business.

“infomediaries.” Industry exchanges bring together multiple buyers and sellers within one industry: Chemdex.com allows scientists to locate over 250,000 laboratory chemicals from 120 suppliers. Other infomediaries gather together vendors in many industries. SupplyBase brings together over 30,000 online supplier directories. Users can search a central database by geography, industry, technology, or other criteria.

online experience by bringing together a combination of information, goods, and services from many individual companies. Catalog City and Shopping.com are two examples of shopping sites, while Intelihealth is a specialized portal offering medical data, health tips, and services such as online pharmacies and health insurance.

Companies often incorporate more than one business model into their e-commerce strategy. Yahoo!, for example, began as an advertising-supported Internet directory. It is now a leading portal where visitors can make travel reservations, shop, and bid at its own auction site.

Fortune 500 corporations and small businesses alike are embracing business-to-business e-commerce to save hundreds of millions of dollars through lower costs and reduced inventories. Business-to-business e-commerce includes all aspects of the supply chain, from product information to order, invoice, fulfillment, payment, and customer service. About 60 percent of purchasing managers rely on the Web to find supplies, and that number is quickly climbing. Companies without a Web site will lose business opportunities. In addition to Web-based e-commerce, many electronic data interchange (EDI) networks are moving to the Internet, replacing expensive proprietary networks….

Extranets are becoming a popular business-to-business e-commerce tool for such activities as purchasing, inventory management, order fulfillment, information transmission, training, and sales presentations. Like an intranet, an extranet is a private network that uses Internet technology and a browser interface. Extranets, however, are accessible only to authorized outsiders with a valid user name and password. Companies can easily designate specific portions of their Web sites to share specific information and processes with suppliers, vendors, partners, customers, and other businesses at remote locations. For example, customers can find account balances and customized catalogs with account-specific pricing.

Extranets are a very efficient format for business-to-business e-commerce and could handle 40 percent of these transactions by 2002. Marine Power Europe, a manufacturer of boat parts, saves $1 million a year in order placement and processing costs.

Since Amazon.com turned the retailing world on its head in 1994, selling consumer goods over the Internet has become big business. By 1999, more than 90,000 established retailers and new businesses had opened the doors to their cybershops, with new merchants joining them daily.

The 1999 holiday shopping season continued the upward trend that began in 1998. Online sales reached $10.5 billion, triple the 1998 levels. About 15 percent of the U.S. population shopped on the web, more than double the previous year’s number. More customers, including new Web purchases—accepted the Web as a shopping medium. And once the took the plunge, they came back spending an average of $1,080 online.

What do e-shoppers buy? Travel accounts for by far the most revenues, as Exhibit 18-4, page 545, followed by computer hardware and software, financial brokerage, and collectibles (person to person auctions). In general, computer services, electronics, and low-risk, low-cost items sell best.

E-tailing is becoming the driver of primary demand in the retail sector. In fact, the internet now influences over half of all retail spending in the United States. Successful early adopters like Costco, the Gap, and Office Depot recognized that the Web was another way to reach customers and complement their basic business. As Toys “R” Us learned, traditional retailers without an online presence lose sales to their more technologically up-to-date rivals….

Despite the increasing popularity of e-shopping, less than 5 percent of e-tailers are expected to show profits in the near term. Currently, the most profitable Internet-related companies are not the e-tailers, but rather the companies that provide infrastructure—computer, computer, networking, and telecommunications equipment providers and telecommunication carriers. In these first stages of e-commerce, businesses are finding that they must focus on developing a solid infrastructure and building online relationships and brands, not on generating short-term profits. It will take time for the financial benefits of e-commerce, such as reduced overhead, to reach the bottom line.

In the meantime, e-tailers are finding it hard to achieve a profit for several reasons:

Internet that merchants get into price wars that cut margins considerably. After Amazon.com offered 30 percent off best-sellers, Barns & Noble raised its discount to 40 percent, Wal-Mart followed with 45 percent, and Buy.com out did them all with 50 percent.

costs, operating expenses are higher than anticipated. As the cost comparison in Exhibit 18-5, page 547, shows, online merchants must offer lower prices—but still incur higher expenses than a competing superstore. Online “real estate” (renting space at other sites through ads or other placements) and marketing are expensive. Barns & Nobel paid AOL, the most popular online shopping mall, $40 million to be its exclusive bookseller for four years. In addition, online customer support hasn’t eliminated the need for telephone support. Online shoppers jammed phone lines during the 1998 holiday season. Shopping.com had to double its call center support staff because of waits as long as an hour.

the e-commerce shores have to grow quickly, and this growth is expensive. To build a brand name, market share, and a loyal customer base, companies make large investments in marketing and improved technology. Even as revenues soar, leaders like Amazon.com and @Home, a provider of high-speed cable Web service, continue to post losses. Industry analysts support and predict that profitability will follow.

Like many traditional retailers, the Boarders bookstore chain reluctantly opened a Web store just to keep pace with Amazon and Barnes & Nobel. Boarders spent $10 million to develop the site, plus another $15 million for a separate distribution center, and expects to incur high costs to upgrade and maintain the site. These expenses do not include marketing costs to attract visitors to the site, which can go as high as 65 percent of sales. Boarders also worries that its Web site may take customers away from its stores and their higher margin sales….

Although e-tailers want to make money from their Web sites, most firms must also look beyond the bottom line. As the following section explains, e-commerce brings many other worthwhile benefits, such as substantial savings in costs and time, improved quality of service, and better customer relationships.

As many examples in this book demonstrate, companies that use the Internet effectively gain clear advantages. Among the attractions of incorporating e-commerce into business strategies are the following:

possible for corporate purchasing agents and individuals to find numerous vendors and retailers for almost any product.

develop customer lists and learn their buying characteristics. The can also immediately learn which products are selling best.

Web sites provide extensive product information for prospective customers around the world on a “24/7” basis, thereby expanding markets and facilitating more transactions—without hiring additional personnel. Customers themselves decide how much information they require by clicking on site links. Well-designed sites offer solutions to customer problems and make product suggestions.

major benefit of e-commerce. These can take many forms, from the distribution savings shown in Exhibit 18-6, page 549, to staff reductions and lower costs of purchasing supplies. A report by the Organization for Economic Cooperation and Development (OECD) indicates that companies can reduce customer service costs by 10 to 50 percent and order processing time by 50 to 96 percent, depending on the type of business.

design and manufacturing. No longer do companies have to design and build products well in advance of the sale, basing product decisions on market research. The can use the Internet to take orders for products tailored to customer specifications. Dell Computers was one of the first to allow computer buyers to configure their ideal computer from menus at Dell’s Web site. Even though Dell’s build-to-order procedures were remarkably efficient when customers phone in their orders, the Web has increased its efficiency and profitability. Warehouses receive supply orders via Internet messages every two hours instead of daily faxes. Suppliers know about the company’s inventory and production plans and get feedback on their performance in meeting shipping deadlines. Inventory on hand is a low 8 days, versus Compaq’s 26, and revenue is up 55 percent.

Despite the increasing acceptance of e-commerce, companies are encountering some barriers along the information Superhighway. Some of the problems include the following:

that start to sell directly to customers can jeopardize relationships with distributors.

online to shop, they easily become frustrated when technology doesn’t perform flawlessly. The top three reasons for dissatisfaction were product availability problems, high shipping and handling costs, and slow Web site performance. Customer service has improved, but during the busy 1999 holiday season 53% of shoppers responding to a survey didn’t receive a product in time, and 30% had to pay extra money for on-time delivery.

payment methods, customers must enter personal information and credit card data at each online store. About 27 percent of Net shoppers find this enough of a nuisance to leave a site before completing their orders. Electronic commerce modeling language (ECML), a standard technology endorsed by a consortium of major technology companies and by Visa and MasterCard, may solve this problem. With ECML, shoppers enter information into their “digital wallet” just once, accessing it when they want to make a purchase.

order merchandise over the Web, even though they readily give out credit card numbers over the telephone or in retail stores. The increasing availability of special secure sites that encrypt personal data is solving this problem. We’ll discuss privacy issues later in the chapter.

E-commerce involves more than building a flashy Web site to attract customers. It’s also about adding value. Internet shoppers don’t just want to duplicate the in-store experience when they visit a company’s Web site—they want a better experience than they can get in their local store. In addition, e-commerce requires the right infrastructure to retain customers and encourage repeat purchases. In and of itself, e-commerce cannot make a company a winner. “If you don’t have the right product, the right timing, and the right distribution channels, the Internet won’t change that,” says Bruce Temkin of Forrester Research.

Businesses can get involved with e-commerce in stages, as Exhibit 18-7, page 550, illustrates. A company might start with a simple promotional Web site (Level 1) or go a step further and add marketing and interactive capabilities that enhance the ability to get and keep customers (Level 2). Next, it can totally integrate its Web activities into it’s existing business structure (Level 3). These three levels supplement rather than replace business procedures that can be performed offline. At level 4, the highest level of strategic value, the company is transformed as it creates new business and shifts traditional business to the Internet.

As the potential benefits from the site increase, so do the costs. Developing a successful e-commerce strategy also takes time. Companies may not achieve positive returns on their Internet investment until they reach level 3. Moving up the learning curve by working through the first levels before implementing more sophisticated technology is more likely to lead to success than attempting to transform the business in one step.

Once a company decides to roll out or expand an e-commerce strategy, it faces a series of high-level decisions involving merchandising, Web site design, marketing, customer service and order fulfillment, Web operations, and infrastructure. These decisions, summarized in Exhibit 18-8, form a road map leading to an Internet strategy that complements the firm’s overall business strategy.

Merchandising/Product Which products to sell. Complete and accurate

product descriptions. Pricing, inventory

management, and analysis.

Web Site Costs/Design Site budget that includes maintenance and updates.

Easy navigation, quality content, visual appeal,

quick downloads.

Marketing Partnerships, advertising, promotions, reward

programs, personal email.

Customer Service/ Prompt response to questions, easy to use order

Order Fulfillment forms, prompt order fulfillment, order tracking

returns policy.

Web Site Operations Site hosting, testing of Web pages, Maintenance

Security.

Infrastructure Required hardware and software, integration with

other information systems, staffing.

Many companies underestimate the effort required to effectively merchandise products on the Internet. First they must decide which products to sell and how to price them. Not all products can be sold successfully online. And slapping a picture of a product on a site with a basic description isn’t sufficient. Successful sites provide guidance and have accurate and lively product descriptions. Other merchandising issues include testing to make sure links to product pictures and descriptions are correct and designing easy-to-use order forms.

Establishing an e-commerce Web site has become much easier in the past few years. Off-the-shelf software packages costing as little as $100 provide templates for sales-oriented Web sites. Packages with more sophisticated features like search engines and databases to manage inventory cost about $2,000 to $5,000. Companies can also hire a Web designer or outsource Web site development to a specialist. As Exhibit 18-7, page 550, shows, the cost of a corporate Web site ranges from $30,000 to over $2 million and includes not only the design and equipment but also updates to the site content and technology and maintenance. On average, however, corporate Web sites cost about $250,000 to develop and $180,000 to maintain. For sites with online purchasing capabilities, the averages rise to $370,000 and $275,000 respectively….

Building brand equity is critical for e-commerce marketing. The first companies to build an online relationship with the consumer have a large advantage. Superbuild.com, a Seattle-based online home improvement merchant, hopes that “getting there first, getting the brand name out” will give it an edge over the Home Depot and Lowe’s chains, which are taking time to refine their online strategies. Other online merchants believe that only companies that focus 100 percent on Web selling will succeed. Home Depot is confident that its strong brand name will give it leverage.

…Companies use a variety of strategies to achieve these marketing objectives including:

Partnerships with other organizations, such as alliances with customer providers like AOL or with complementary retailers for placement of banner ads.

banner ads, companies can buy sponsorships on Web pages that put their message into the content of the other Web sites.

email for example, email newsletters with notices of sale items, an email dollars-off coupon for customers who haven’t ordered for a while, and sweepstakes giving away trips and popular products.

individual merchants or companies like ClickRewards that offer rewards for purchases like ClickRewards that offer awards for purchases at member sites.

driving traffic to Web sites and improving customer retention. This type of email marketing costs less than banner advertising and has ha much higher “click-through” rate—an average of 18 percent, compared to 0.65 on banner ads.

What brings site visitors back? For 75 percent of Web surfers, high-quality content is the key. Other criteria include ease of use, fast download time, and frequent updates.

On the Internet, disgruntled shoppers usually don’t wait around. Slow service? Poor information? Difficult ordering process? With just a click of the mouse, consumers find another site that makes shopping easier. Therefore, good customer service and order fulfillment are critical to gaining a competitive edge on the Internet.

….Companies are reevaluating operational strategies in response to the realities of e-commerce. As noted earlier, companies like Buy.com are outsourcing the distribution process to reduce warehouse and inventory holding costs. Amazon.com switched from outsourcing to in-house order fulfillment and distribution and now goes directly to publishers for most of its purchases.

When planning an Internet strategy, managers must develop a plan for Web site operations and infrastructure. Some of the questions they need to ask include:

Once the Web site is online, managers must have a way to evaluate its effectiveness. They also need to know whose sites are best for their ads and promotions.

Measuring the return on an Internet investment is no easy task, however. As yet, the Web offers no standard measurement procedures. Auditing services used different methods to analyze Web-traffic data, often with conflicting results. Some common measurements include page impressions (number of times a page is seen), reach (number of unique visitors to a site), total number of site visits, time online, and click throughs on linked ads. Companies must use caution in interpreting these results, however. A service that tells a company how many times its site is seen may not know if the visitor spends time on a page or quickly links to another site.

Predictions of a Jetsons-like future for the Internet abound. Within 10 years, we could live in a world where everything is interconnected through the Net. An in-home network would know to turn the coffee maker on at a different time during the week and on weekends. Sprinkler systems would check the Web’s weather reports and turn off if rain is expected. Manufacturers will use built-in Net links to diagnose and perhaps even fix problems with your kitchen appliances. Your refrigerator may be able to tell when supplies run low and generate orders from online grocers. ….Other trends include one-to-one marketing, better privacy policies, and industry consolidation.

The Internet’s ability to provide companies with a new, more effective link with customers could make it the most powerful direct marketing tool yet. Already it is creating new types of one-to-one marketing models. The Web’s unique ability to provide immediate communication with and feedback from customers will allow merchants to meet customer demands on an individual basis. One year after implementing customized services, sites reported 47 percent growth in new customers and a 52 percent increase in sales.

Many different types of sites use personalization to create customer loyalty and increase purchases. Portal sites like Yahoo! and Excite let users create personalized pages with an email box, news on specific topics, weather for their hometown, sports scores, and reminders of upcoming events like birthdays….

The Web’s ability to provide personalized service comes at a price. Consumers have to supply personal information, raising concerns about privacy. The Web site’s ability to follow an electric trail is another issue. In early 1999, a study requested by the Federal Trade Commission showed that about two-thirds of all commercial Web sites warn the visitor that they collect personal information. Of those sites, only 10 percent also told customers that they could refuse to provide information and that they could review data collected at the site.

In response to consumer concerns, companies are posting their privacy policies on their Web sites. These policies tell consumers what information the site collects and how it will be used….

In the early days of the Internet, small, nimble companies took the lead. In just a few years, many of those companies became major forces in e-commerce. Some forward-thinking established companies also recognized the Internet’s power and joined the e-commerce community. Many others, however, decided to wait until the Net became more developed, sure that their size would enable them to trample the newcomers. But the fast pace of the Internet means that those who wait, lose. Those who arrived first have already moved to the next level of e-commerce.

….Other online retailers are using strategic alliances to ward off Amazon’s encroachment on their territory. CDNow’s Jason Olim partnered with eToys, Cyberian Outpost, Reel.com, DatekOnline, Virtual Vineyards, Preview Travel, Garden Escape, and PC Flowers and Gifts to create ShopperConnection, a retail hub site.

Industry consolidation is also on the rise. Companies are acquiring rivals and having companies in other e-commerce categories to stake out a larger claim on cyberspace. AOL has been a major acquirer of e-commerce companies such as When.com, which developed a personalized online calendar and event schedule, and ICQ, a developer of Internet instant messaging technology.

One of the biggest challenges you will face in your business career is keeping up with the Internet industry. By the time you read this chapter, new developments in access speed, voice and data transmission, and e-commerce will be making headlines. Just as in other areas of information technology, acquiring and maintaining Internet-related skills will serve you well in the future.

You will be called on to help your company go online or make its Web site more effective. A study by Boston information technology researcher Yankee Group found that about 46 percent of small businesses still do not have a Web presence. And often small and medium-sized companies that are online do not know how to use the Internet to improve their business. Says Yankee Group’s Michael Lauricella, “The Web site is more of a toy than a business tool.

What makes a Web site a winner? According to four Web experts interviewed by the Wall Street Journal Interactive Addition, a site’s overall look and “feel,” layout, content, and ease of use are among the most important features. Simple, visually appealing layouts won praise. But the best Web sites have more than attractive design elements. The Web designers also included good prices and service in their list of “must-haves.” Even the most attractive Web site will fail if the company doesn’t fill orders promptly and provide good customer service. Here are some guidelines for creating effective Web sites:

will move on to one of the millions of other sites unless they can see what the site is within 10 seconds, what’s it’s about within the next 10 seconds, and how it’s organized and what links it has in 10 more seconds.

- Make navigation easy. Users want to move around a site as quickly as possible. Two common navigational tools are tabs along the top of the screen and a navigation bar on the top left side. Search features also help visitors find what they need. Make sure the links work.

effects can make pages slow to load. Customers quickly become frustrated and will leave a site without ordering if they have to wait for images to appear. Offering a text-only version of your site makes it easier for visitors with slower machines to access information.

small screen. Users prefer to see headlines and article summaries, with links to the complete article for those who want more information.

Suppose your company wants to start an online business venture. If you want your Web site to generate sales and repeat visits, you should start by analyzing the company’s readiness for e-commerce. Here are some critical questions to ask:

You can also use similar questions to evaluate the success of an existing operation. In addition, you would determine the number of visitors, the percentage who buy, how well the order fulfillment and customer service procedures work, and what improvements and upgrades are necessary.

how businesses operate. It combines high-speed communications and computing power to transmit information immediately. All networks in the Internet use TCP/IP, a special language that allows different types of computers to communicate. In addition to the resources of the World Wide Web, the Internet provides file transfer capabilities, email, chat sessions, and newsgroups. Data travel from the user’s access point to the Internet service provider and then through a series of interlinked national backbones to the recipient’s ISP.

About 378 million people worldwide use the Internet. About 95 million in the United States are regular users. Although adaptors of the technology were younger, more affluent, and better educated than the general population, the profile of the Net user is moving closer to the national averages in these areas. Among the most popular Web sites are those with company and product information, news, reference materials, periodicals, financial quotes, and entertainment. Businesses use the Internet to research economic trends; gather industry information; learn about competitors; provide customer service; communicate with employees, vendors, and customers; market and sell products; and purchase supplies.

The competitive arena is expanding as the Internet eliminates barriers of time and place and reduces barriers to entry. Channel relationships are changing as well. The Internet allows companies to sell directly to consumers without using distributors. Some distributors are finding new roles by providing services to online merchants who want to outsource order fulfillment. The Internet also empowers consumers by increasing access to information and making it easy to compare prices.

Internet, has two market segments: business-to-business and business-to-consumer. The business-to-business market accounts for about 75 percent of all e-commerce revenue. Among the many models for e-commerce are selling goods and services over the Web, providing information for a fee, supporting an information or entertainment site with advertising or referral fees, facilitating sales through auctions, providing e-commerce-enabling services, and gathering industry or consumer information into “infomediary” sites.

procedures. It offers the convenience of lower prices, greater selection of products and vendors, around-the-clock ordering and customer service availability (increasingly important to the global economy), ease of updating and distributing of product catalogs without incurring print costs, and the ability to track customer and product sales data. Companies can eliminate intermediaries and sell directly to consumers and can offer customized products. The increased efficiency results in better customer service, lower transaction costs, and new relationship-building strategies.

with a basic promotional Web site and then adding order-taking and customer service features. More sophisticated strategies integrate Web activities into a company’s existing business structure. To implement an e-commerce strategy, companies must consider merchandising, Web site costs and design, marketing, customer service and order fulfillment, operations, and infrastructure.

recognize the added value of personalization. Industry and consumer groups are developing solutions to protect customer privacy. Industry leaders are taking steps to protect their turf by acquiring other companies.

As Jared Wells learned when he started his own company, accounting is the backbone of any business. He attributes many of his early problems to his lack of accounting knowledge. Because he was unable to evaluate the advice of his accounting firm, his first QuickBooks system did not meet his company’s needs. Once he understood the basics of accounting, he could decide which financial information was important for his company, what those numbers meant, and how he could use them to make decisions.

Financial information is central to every organization. To operate effectively, businesses must have a way to track income, expenses, assets, and liabilities in an organized manner. Financial information is also essential for decision making. Managers prepare financial reports using accounting, a set of procedures and guidelines for companies to follow when preparing financial reports. Unless you understand basic accounting concepts, you will not be able to “speak” the standard financial language of businesses.

This chapter starts by discussing why accounting is important for businesses and for users of financial information and then presents an overview of accounting procedures. Next the three main financial statements—the balance sheet, the income statement, and the statement of cash flows—are described. The chapter then discusses how to analyze financial statements using ratio analysis. Finally, it explores some of the trends affecting accounting.

Accounting is the process of collecting, recording, classifying, summarizing, reporting, and analyzing financial activities. It results in reports that describe the financial condition of an organization.

The accounting system generates two types of financial reports, as shown in Exhibit 19-2, p. 570: internal and external.

As the term implies, managerial accounting provides financial information that managers inside the organization can use to evaluate and make decisions about current and future operations. For instance, the sales reports prepared by managerial accountants show how well marketing strategies are working. Production cost reports help departments track and control costs. Managers may prepare very detailed financial reports for their own use and provide summary reports to top management.

Financial accounting focuses on preparing external financial reports that are used by outsiders, that is, people who have an interest in the business but are not part of management. Although these reports also provide useful information for managers, they are primarily used by lenders, suppliers, investors, and government agencies to access the financial strength of a business.

To ensure accuracy and consistency in the way financial information is reported, accountants in the United States follow generally accepted accounting principles (GAAP) when preparing financial statements.

The Financial Accounting Standards Board (FASB) is a private organization that responsible for establishing financial accounting standards in the United States.

At the present time, there are no international accounting standards, although the International Accounting Standards Committee is trying to develop them.

Financial statements are the chief element of the annual report, a yearly document that describes a firm’s financial status. Annual reports usually discuss the firm’s activities during the past year and its prospects for the future. Three primary financial statements included in the annual report are discussed and illustrated in this chapter:

The accounting profession has grown rapidly due to the increased complexity, size, and number of businesses and the frequent changes in tax laws. Accounting is now an over $40 billion industry. The more than one million accountants in the United States are classified as either public accountants or private (corporate) accountants.

Independent accountants who serve organizations and individuals on a fee basis are called public accountants. Public accountants offer a wide range fo services, including preparation of financial statements and tax returns, independent auditing of financial records and accounting methods, and management consulting.

Auditing, the process of reviewing the records used to prepare financial statements, is an important responsibility of public accountants.

They provide a formal auditor’s opinion indicating whether the statements have been prepared in accordance with accepted accounting rules. This written opinion is an important part of the annual report.

The largest public accounting firms, called the Big Five, operate worldwide and offer a variety of business consulting services in addition to accounting services. In order of size, they are Pricewaterhouse-Coopers, Anderson Worldwide, KPMG International, Ernst & Young, and Deloitte & Touche Tohmasu International.

To become a certified public accountant (CPA), an accountant must complete an approved bachelor’s degree program and pass a test prepared by the American Institute of Certified Public Accountants. Each state also has requirements for CPAs such as several years’ on-the-job experience and continuing education. Only CPAs can provide the auditor’s opinion on a firm’s financial statements. Most CPAs first work for public accounting firms and later become private accountants or financial managers.

Accountants employed to serve one particular organization are private accountants. Their activities include preparing financial statements, auditing company records to be sure employees follow accounting policies and procedures, developing accounting systems, preparing tax returns, and providing financial information for management decision making. Managerial accountants also have a professional certification program.

Requirements to become a certified management accountant (CMA) include passing an examination.

Using generally accepted accounting principles, accountants record and report financial data in similar ways for all firms. They report their findings in financial statements that summarize a company’s business transactions over a specified time period. As mentioned earlier, the three major financial statements are the balance sheet, income statement, and the statement of cash flows.

People sometimes confuse accounting with bookkeeping. Accounting is a much broader concept. Bookkeeping, the system used to record a firm’s financial transactions, is a routine, clerical process. Accountants take bookkeepers’ transactions, classify and summarize the financial information, and then prepare and analyze financial reports. Accountants also develop and manage financial systems and help plan the firm’s financial strategy.

The accounting procedures used today are based on those developed in the late fifteenth century by an Italian monk, Brother Luca Pacioli. He defined the three main accounting elements as assets, liabilities, and owner’s equity.

Assets are things of value owned by a firm. They may be tangible, such as cash, equipment, and buildings, or intangible, such as a patent or trademarked name.

Owner’s equity is the total amount of investment in the firm minus any liabilities. Another term for owner’s equity is net worth.

The relationship among these three elements is expressed in the accounting equation:

The accounting equation must always be in balance (that is, the total of the elements on one side of the equals sign must equal the total on the other side). Suppose you start a bookstore and put $10,000 in cash into the business. At that point, the business has assets of $10,000 and no liabilities. This would be the accounting equation:

The liabilities are zero and the owner’s equity (the amount of your investment in the business) is $10,000. The equation balances.

To keep the accounting equation in balance, every transaction must be recorded as two entries. As each transaction is recorded, there is an equal and opposite event so that two accounts or records are changed. This method is called double-entry bookkeeping.

Suppose that after starting your bookstore with $10,000 cash, you borrow another $10,000 from the bank. The accounting equation will change as follows:

Now you have $20,000 in assets—your $10,000 in cash and the $10,000 loan proceeds from the bank. The bank loan is also recorded as a liability of $10,000 because it’s a debt you must repay. Making two entries keeps the equation in balance.

The accounting cycle refers to the process of generating financial statements, beginning with a business transaction and ending with the preparation of the report.

Exhibit 19-3 shows the six steps in the accounting cycle. The first step in the cycle is to analyze the data collected from many sources. All transactions that have a financial impact on the firm—sales, payments to employees and suppliers, interest and tax payments, purchases of inventory, and the like—must be documented. The accountant must review the documents to make sure they’re complete.

Next each transaction is recorded in a journal, a listing of financial transactions in chronological order.

Then the journal entries are recorded in ledgers, which show increases and decreases in specific asset, liability, and owner’s equity accounts.

The ledger totals for each amount are summarized in a trial balance, which is used to confirm the accuracy of the figures. These values are used to prepare financial statements and management reports. Finally individuals analyze these reports and make decisions based on the information in them.

As discussed in Chapter 17, computers have become part of accounting activity in almost all firms, performing most of the mechanics of accounting. Because they can quickly and accurately handle large amounts of data, computers streamline the routine aspects of accounting so the accountant can focus on interpreting financial information. With computerized accounting systems, an entry generates the appropriate changes to other related parts.

Computerized accounting programs do many different things. Most accounting packages offer six basic modules that handle general ledger, sales or order, accounts receivable, purchase order, accounts payable, and inventory control functions. Tax programs use accounting data to prepare tax returns and tax plans. Computerized point-of-sale terminals used by many retail firms automatically record sales and do some of the bookkeeping. The Big Five and many other large public accounting firms develop accounting software for themselves and for clients.

The balance sheet, one of three financial statements generated from the accounting system, summarizes a firm’s financial position at a specific point in time. It reports the resources of a company (assets), the company’s obligations (liabilities), and the difference between what is owned (assets), and what is owed (liabilities), or owners’ equity.

The assets are listed in order of their liquidity, the speed with which they can be converted to cash. The most liquid assets come first, and the least liquid are last. Because cash is the most liquid asset, it is listed first. Buildings, on the other hand, have to be sold to be converted to cash, so they are listed after cash. Liabilities are arranged similarly: liabilities due in the short term are listed before those due in the long term.

The balance sheet at December 31, 2002 for Delicious Desserts, Inc., an imaginary bakery, is illustrated in Exhibit 19-4. The basic accounting equation is reflected in the three totals highlighted on the balance sheet: assets of 148,900 equal the sum of liabilities and owners’ equity ($70,150 + $78,750).

Delicious Desserts, Inc.

Balance Sheet as of December 31, 2002

Assets

Current Assets:

Cash $15,000

Marketable securities 4,500

Accounts receivable $45,000

Less: Allowance for doubtful 1,300 43,700

accounts

Notes receivable 5,000

Inventory 15,000

Total current assets $83,200

Fixed assets:

Bakery equipment $56,000

Less: Accumulated depreciation 16,000 $40,000

Furniture and fixtures $18,450

Less: Accumulated depreciation 4,250 14,200

Total fixed assets 54,200

Intangible assets:

Trademark $ 4,500

Goodwill 7,000

Total intangible assets 11,500

Total assets $148,900

Liabilities and Owners’ Equity

Current liabilities:

Accounts payable $30,650

Notes payable 15,000

Accrued expenses 4,500

Income taxes payable 5,000

Current portion of long-term debt 5,000

Total current liabilities $60,150

Long-term liabilities:

Bank loan for bakery equipment $10,000

Total long-term liabilities 10,000

Total liabilities $ 70,150

Owners’ equity

Common stock (10,000 shares outstanding) $30,000

Retained earnings 47,750

Total owners’ equity 70,750

Total liabilities and

owners' equity $148,900

Assets can be divided into three broad categories: current assets, fixed assets, and intangible assets. Current assets are assets that can or will be converted to cash within the next 12 months. They are important because they provide the funds used to pay the firm’s current bills. They also represent the amount of money the firm can quickly raise. Current assets include:

Fixed assets are long-term assets used by the firm for more than a year. They tend to be used in production and include land, buildings, machinery, equipment, furniture, and fixtures. Except for land, fixed assets wear out and become outdated over time. Thus, they decrease in value every year.

This declining value is accounted for through depreciation. Depreciation is the allocation of the asset’s original cost to the years in which it is expected to produce revenues. A portion of the cost of a depreciable asset—a building or piece of equipment, for instance—is charged to each of the years it is expected to provide benefits. This practice helps match the asset’s cost against the revenues it provides. Since it is impossible to know exactly how long an asset will last, estimates are used. They are based on past experience with similar items or IRS guidelines for assets of that type. Notice that through 2002, Delicious Desserts has taken a total of $16,000 in depreciation on its bakery equipment.

Intangible assets are long-term assets with no physical existence. Common examples are patents, copyrights, trademarks, and goodwill.

Patents and copyrights shield the firm from direct competition, so their benefits are more protective than productive. For instance, no one can use more than a small amount of copyrighted material without permission from the copyright holder.

Trademarks are registered names that can be sold or licensed to others. Delicious Desserts’ intangible asset is a trademark valued at $4,500.

Goodwill occurs when a company pays more for an acquired firm than the value of its tangible assets.

Liabilities are the amounts a firm owes to creditors. Those liabilities coming due sooner—current liabilities—are listed on the balance sheet, followed by long-term liabilities.

Current liabilities are those due within a year of the date of the balance sheet. These short-term claims may strain the firm’s current assets because they must be paid in the near future. Current liabilities include:

must be repaid within a year. For example, Delicious Desserts has a six-month, $15,000 loan from its bank that is a note payable.

Long-term liabilities come due more than one year after they date of the balance sheet. They include bank loans (such as Delicious Desserts’ $10,000 loan for bakery equipment), mortgages on buildings, and the company’s bonds sold to others.

Owners’ equity is the owners’ total investment in the business after all liabilities have been paid. For sole proprietorships and partnerships, amounts put in by the owners are recorded as capital. In a corporation, the owners provide capital by buying the firm’s common stock. For Delicious Desserts, the total common stock investment is $30,000.

Retained earnings are the amounts left over from profitable operations since the firm’s beginning. They are total profits minus all dividends (distributions of profits) paid to stockholders. Delicious Desserts has $48,750 in retained earnings.

The balance sheet shows the firm’s financial position at a certain point in time. The income statement summarizes the firm’s revenues and expenses and shows its total profit or loss over a period of time. Most companies prepare monthly income statements for management and quarterly and annual statements for use by investors, creditors, and other outsiders. The primary elements of the income statement are revenues, expenses, and net income (or loss). The income statement for Delicious Desserts for the year ended December 31, 2002 is shown in Exhibit 19-5.

Delicious Desserts, Inc.

Income Statement for the Year Ended December 31, 2002

Revenues

Gross sales $275,000

Less: Sales discounts 2,000

Less: Return and allowances 2,000

Net Sales $270,500

Cost of Goods Sold

Beginning inventory, January 1 $ 18,000

Cost of goods manufactured 109,500

Total cost of goods available for sale $127,500

Less: Ending inventory December 31 15,000

Cost of goods sold 112,500

Gross profit $158,000

Operating Expenses

Selling expenses

Sales salaries $31,000

Advertising 16,000

Other selling expenses 18,000

Total selling expenses $65,000

General and administrative expenses

Professional and office salaries $20,500

Utilities 5,000

Office supplies 1,500

Interest 3,600

Insurance 2,500

Rent 17,000

Total general and administrative

Expenses 50,100

Total operating expenses 115,100

Net profit before taxes $ 42,900

Less: Income taxes 10,725

Net profit $ 32,175

Revenues are the dollar amount of sales plus any other income received from sources such as interest, dividends, and rents. The revenues of Delicious Desserts arise from the sales of its bakery products.

Revenues are determined starting with gross sales, the total dollar amount of a company’s sales. Delicious Desserts had two deductions from gross sales.

Sales discounts are price reductions given to customers that pay their bills early. For example, Delicious Desserts gives sales discounts to restaurants that buy in bulk and pay at delivery.

Returns and allowances is the dollar amount of merchandise returned by customers because they didn’t like a product or because it was damaged or defective.

Net sales is the amount left after deducting sales discounts and returns and allowances from gross sales. Delicious Desserts’ gross sales were reduced by $4,500, leaving net sales of $270,500.

Expenses are the costs of generating revenues. Two types are recorded on the income statement: cost of goods sold and operating expenses.

The cost of goods sold is the total expense of buying or producing the firm’s goods or services. For manufactures, cost of goods sold includes all costs directly related to production: purchases of raw materials and parts, labor, and factory overhead (utilities, factory maintenance, machinery repair). For wholesalers and retailers, it is the cost of goods bought for resale. For all sellers, cost of goods sold includes all the expenses of preparing the goods for sale, such as shipping and packaging.

Delicious Desserts’ cost of goods sold is based on the value of inventory on hand at the beginning of the accounting period, $18,000. During the year, the company spent $109,500 to produce its baked goods. This figure includes the cost of raw materials, labor costs for bakery workers, and the cost of operating the bakery area. Adding the cost of goods manufactured to the value of beginning inventory, we get the total cost of goods available for sale, $127,500. To determine the cost of goods sold for the year, we subtract the cost of inventory at the end of the period.

The amount a company earns after paying to produce or buy its products but before deducting operating expenses is the gross profit. It is the difference between net sales and cost of goods sold. Since service firms do not produce goods, their gross profit equals net sales. Gross profit is a critical number for a company because it is the source of funds to cover all the firm’s other expenses. Analyzing gross profits by product can translate into higher profits.

The other major expense category is operating expenses. These are the expenses of running the business that are not related directly to producing or buying its products. The two main types of operating expenses are selling expenses and general and administrative expenses.

Selling expenses are those related to marketing and distributing the company’s products. They include salaries and commissions paid to salespeople and the costs of advertising, sales supplies, delivery, and other items that can be linked to sales activity, such as insurance, telephone and other utilities, and postage.

General and administrative expenses are the business expenses that cannot be linked to either cost of goods sold or sales. Examples of general and administrative expenses are salaries of top managers and office support staff; office supplies; fees for accounting, consulting, and legal services; insurance; rent; and utilities. Delicious Desserts’ operating expenses totaled $115,100.

The final figure—or bottom line—on an income statement is the net profit (or net income) or net loss. It is calculated by subtracting all expenses from revenues. If revenues are more than expenses, the result is a net profit. If expenses exceed revenues, a net loss results.

Several steps are involved in finding net profit or loss. (These are shown in the right-hand column of Exhibit 19-5.) First, cost of goods sold is deducted from net sales to get the gross profit. Then total operating expenses are subtracted from gross profit to get the net profit before taxes. Finally income taxes are deducted to get the net profit. As shown in Exhibit 19-5, Delicious Desserts earned a net profit of $32,175 in 2002.

It is very important to recognize that profit does not represent cash. The income statement is a summary of the firm’s operating results during some time period. It does not present the firm’s actual cash flows during the period. Those are summarized in the statement of cash flows, which is discussed briefly in the next section.

Net profit or loss is one measure of a company’s financial performance. However, creditors and investors are also keenly interested in how much cash a business generates and how it is used. The statement of cash flows, a summary of the money flowing into and out of a firm, is the financial statement used to assess the sources and uses of cash during a certain period, typically one year. All publicly traded firms must include a statement of cash flows in their financial reports to shareholders. The statement of cash flows tracks the firm’s cash receipts and cash payments. It gives financial managers and analysts a way to identify cash flow problems and assess the firm’s financial viability.

Using income statement and balance sheet data, the statement of cash flows divides the firm’s cash flows into three groups:

Delicious Desserts, Inc.

Statement of Cash Flows for 2002

Cash Flow from Operating Activities

Net profit after taxes $27,175

Depreciation 1,500

Decrease in accounts receivable 3,140

Increase in inventory (4,500)

Decrease in accounts payable (2,065)

Decrease in accruals (1,035)

Cash provided by operating activities $24,215

Cash Flow from Investment Activities

Increase in gross fixed assets ($5,000)

Cash used in investment activities ($5,000)

Cash Flow from Financing Activities

Decrease in notes payable ($3,000)

Decrease in long-term debt (1,000)

Cash used by financing activities ($4,000)

Net increase in cash and marketable securities $15,215

Delicious Desserts’ statement of cash flows for 2002 is presented in Exhibit 19-6. It shows that the company’s cash and marketable securities have increased over the last year. And during the year the company generated enough cash flow to increase inventory and fixed assets and to reduce accounts payable, accruals, notes payable, and long-term debt.

Individually, the balance sheet, income statement, and statement of cash flows provide insight into the firm’s operations, profitability, and overall financial condition. By studying the relationships among the financial statements, however, one can gain even more insight into a firm’s financial condition and performance.

Ratio analysis involves calculating and interpreting financial ratios taken from the firm’s financial statements to assess its condition and performance. A financial ratio states the relationship between amounts as a percentage. For instance, current assets might be viewed relative to current liabilities or sales relative to assets. The ratios can then be compared over time, typically three to five years. A firm’s ratios can also be compared to industry averages or to those of another company in the same industry.

It’s important to remember that ratio analysis is based on historical data and may not indicate future financial performance. Ratio analysis merely highlights potential problems; it does not prove they exist. However, ratios can help managers understand operations better and identify trouble spots.

Ratios can be classified by what they measure: liquidity, profitability, activity, and debt. Using Delicious Desserts’ 2002 balance sheet and income statement (Exhibits 19-4 and 19-5), we can calculate and interpret the key ratios in each group. Exhibit 19-7 summarizes the calculations of these ratios for Delicious Desserts.

Ratio Formula Calculation Result

Liquidity Ratios

Current ratio Total current assets $83,200 1.4

Total current liabilities $60,150

Acid-test (quick) ratio

Total current assets – inventory $83,200 - $15,000 1.1

Total current liabilities $60,150

Net working capital

Total current assets – $83,200 – $60,150 $23,050

Total current liabilities

Profitability Ratios

Net profit margin Net profit $ 32,175 11.9%

Net sales $270,500

Return on equity Net profit $ 32,175 40.9%

Total owners’ equity $ 78,750

Earnings per share Net profit $32,175 $3.22

Number of shares of 10,000

common stock outstanding

Activity Ratio

Inventory turnover Cost of goods sold

Average inventory

Cost of goods sold $112,500

(Beginning inventory + ($18,000 + $15,000)/2

Ending inventory)/2 $112,500 6.8 times

$16,500

Debt Ratio

Debt-to-equity ratio Total liabilities $70,150 89.1%

Owners’ equity $78,750

Liquidity ratios measure the firms ability to pay its short-term debts as they come due. These ratios are of special interest to the firm’s creditors. The three main measures of liquidity are the current ratio, the acid-test (quick) ratio, and the net working capitial.

The current ratio is the ratio of total current assets to total current liabilities. Traditionally, a current ratio of 2 ($2 of current assets for every $1 of current liabilities) has been considered good. Whether it is sufficient depends on the industry in which the firm operates. Public utilities, which have a very steady cash flow, operate quite well with a current ratio below 2. A current ratio of 2 might not be adequate for manufacturers and merchandisers that carry high inventories and have lots of receivables. The current ratio for Delicious Desserts for 2002, as shown in Exhibit 19-7, is 1.4. This means little without a basis for comparison. If the analyst found that the industry average for small bakeries was 2.4, Delicious Desserts would appear to have low liquidity.

The acid test (quick) ratio is like the current ratio except that it excludes inventory, which is the least liquid current asset. The acid-test ratio is used to measure the firm’s ability to pay its current liabilities without selling inventory. The name acid-test implies that this ratio is a critical test of the firm’s liquidity. And acid-test ratio of at least 1 is preferred. But, again, what is an acceptable value varies by industry. The acid-test ratio is a good measure of liquidity when inventory cannot easily be converted to cash (for instance, if it consists of very specialized goods with a limited market). If inventory is liquid, the current ratio is better. Delicious Desserts’ acid-test ratio for 2002 is 1.1. Because the bakery’s products are perishable, it does not carry large inventories. Thus, the values of its acid-test and current ratios are fairly close. As a manufacturing company, however, inventory typically makes up a large portion of current assets, so the acid-test ratio will be lower than the current ratio.

Net working capital, though not really a ratio, is often used to measure a firm’s overall liquidity. It is calculated by subtracting total current liabilities from total current assets. Delicious Desserts’ net working capital for 2002 is $23,050. Comparisons of net working capital over time often help in assessing a firm’s liquidity.

To measure profitability, a firm’s profits can be related to its sales, equity, or stock value. Profitability ratios measure how well the firm is using its resources to generate profit and how efficiently it is being managed. The main profitability ratios are net profit margin, return on equity, and earnings per share.

The ratio of net profit to net sales is the net profit margin, also called return on sales. It measures the percentage of each sales dollar remaining after all expenses, including taxes, have been deducted. Higher net profit margins are better than lower ones. The net profit margin is often used to measure the firm’s earning power. “Good” net profit margins differ quite a bit from industry to industry. A grocery store usually has a very low net profit margin, perhaps below 1 percent, while a jewelry store’s net profit margin would probably exceed 10 percent. Delicious Desserts’ net profit margin for 2002 is 11.9 percent. In other words, Delicious Desserts’ net profit margin for 11.9 cents on each dollar of sales.

The ratio of net profit to total owners’ equity is called return on equity (ROE). It measures the return that owners receive on their investment in the firm, a major reason for investing in a company’s stock. Delicious Desserts’ has a 40.9 percent ROE for 2002. On the surface, a 40.9 percent ROE seems quite good. But the same level of risk in the business and the ROE of other firms in the same industry must also be considered. The higher the risk, the greater the ROE investors look for. A firm’s ROE can also be compared to past values to see how the company is performing over time.

Earnings per share (EPS) is the ratio of net profit to the number of shares of common stock outstanding. It measures the number of dollars earned by each share of stock. EPS values are closely watched by investors and are considered an important sign of success. EPS also indicates a firm’s ability to pay dividends. Note that EPS is the dollar amount earned by each share, not the actual amount given to stockholders in the form of dividends. Some earnings may be put back into the firm. Delicious Desserts’ EPS for 2002 is $3.22.

Activity ratios measure how well a firm uses its assets. They reflect the speed with which resources are converted to cash or sales. A frequently used activity ratio is inventory turnover.

The inventory turnover ratio measures the speed with inventory moves through the firm and is turned into sales. It is calculated by dividing cost of goods sold by the average inventory. (Average inventory is estimated by adding the beginning and ending inventories for the year and dividing by 2) On average, Delicious Desserts’ inventory is turned into sales 6.8 times each year, or about once every 54 days (365 days / 6.8). The acceptable turnover ratio depends on the line of business. A grocery store would have a high turnover ratio, maybe 20 times a year, whereas the turnover for a heavy equipment manufacturer might be only 3 times a year.

Debt ratios measure the degree and effect of the firm’s use of borrowed funds (debt) to finance its operations. These ratios are especially important to lenders and investors. They want to make sure the firm has a healthy mix of debt and equity. If the firm relies too much on debt, it may have trouble meeting interest payments and repaying loans. The most important debt ratio is the debt-to-equity ratio.

The debt-to-equity ratio measures the relationship between the amount of debt financing (borrowing) and the amount of equity financing (owners’ funds). It is calculated by dividing total liabilities by owners’ equity. In general, the lower the ratio, the better. But it is important to assess the debt-to-equity ratio against both past values and industry averages. Delicious Desserts’ ratio for 2002 is 89.1 percent. The ratio indicates that the company has 89 cents of debt for every dollar the owners have provided. A ratio above 100 percent means the firm has more debt than equity. In such a case, the lenders are providing more financing than the owners.

In the past accountants were portrayed primarily as “bean-counters” who overanalyzed financial data and were of little help to the managers and employees who produced the numbers the auditors examined. Although accountants still perform the important task of assuring that a company’s financial reporting conforms to GAAP, they have become a valuable part of the financial team and consult with clients on information technology and other areas as well.

The increasing complexity of today’s business environment creates additional challenges for the accounting profession. The information explosion means that the FASB must consider a greater number of new regulations and develop more position statements to keep up with the pace of change. The FASB also has an emerging issues task force that studies ways to make accounting standards more relevant for today’s companies.

No longer can a company’s assets—brand names, patents, research and development (R&D) costs, and similar expenses—make up a large portion of the value of many information technology companies. As yet, however, there is not accepted way to value those assets; indeed, there is disagreement over whether companies should even try. In other areas GAAP is either unclear or subject to different interpretations.

Moving beyond their traditional task of validating a company’s financial information, accountants now take an active role in advising their clients on systems and procedures, accounting software, and changes in accounting regulations. They also delve into operating information to discover what’s behind the numbers. By examining the risks and weaknesses in a company, they can help managers develop financial controls and procedures to prevent future trouble spots. For example, auditors in a manufacturing company may spend more time on inventory, a likely problem area.

Honeywell, Inc., the $8 billion building-controls company headquartered in Minneapolis, formed a collaborative relationship with Deloitte & Touche, its audit firm (Honeywell and Allied Signal merged in fall 1999). Instead of being a once-a-year event, Honeywell’s audit included quarterly meetings to discuss changes in company operations and accounting regulations. In this way Honeywell learned about upcoming changes in accounting regulations and avoided potential reporting problems before they happened….

As the world’s economy becomes knowledge-based rather than industrial-based, more of a company’s value may come from internally generated intangible intellectual assets such as R&D, brands, trademarks, and employee talent than from traditional tangible assets. Consider, for example, Dell Computer’s direct marketing strategy, Gap’s brand image, and AOL’s subscriber base. How should these be valued? Today’s accounting system is based on historical costs of physical assets. GAAP has no rules for estimating or reporting the value of investments in intangibles. The stock market, on the other hand, places a value on them. In fact, the value of knowledge assets is now approaches or even exceeds the value of reported book assets. This is what creates the huge discrepancy between book value and market value.

Whether and how to value intangibles is a controversial issue. Some people believe that because intangibles are uncertain and risky, they do not belong to the balance sheet. Costs related to intangibles may bear no relationship to their actual value. On the other hand, placing a value on intangibles allows companies to know whether they are earning adequate returns on R&D, whether patents are worth renewing, and whether they should invest more to build brands. Clearly, there are no quick and easy solutions to this issue, which will continue to be studied in the coming years.

Although GAAP is supposed to ensure uniformity of U.S. companies’ financial reporting, in reality companies have some discretion in how they interpret certain accounting standards. Companies appear to be taking advantage of loopholes in GAAP to manipulate numbers. Cendant, for example, was accused of fraudulently inflating income by booking $500 million in fictitious revenues. Many companies are pushing accounting to the edge—and over it—to keep earnings rising to meet the expectations of investment analysts, who project earnings, and investors, who panic when a company misses the analysts’ forecasts. This has raised serious concerns about the quality of earnings and questions about the validity of financial reports.

One of the most common issues involves write offs of certain one-time charges. What is a legitimate one-time charge, and what are normal operating costs that are written off as they are incurred? GAAP doesn’t provide a clear answer. In this category are charges like restructuring charges (combining several years of expected future expenses and writing them off at once) and costs associated with acquisitions, such as “in-process R&D at an acquired company. The acquirer can write off the estimated value of the products still in development. The benefits of this R&D are unknown and may be worthless in the future, so companies must take the charge against earnings now.

The possible elimination of the in-process R&D write-off is still under debate by the FASB and the Securities and Exchange Commission (SEC). The SEC is also concerned with the decreasing quality of financial reporting and may ask for more disclosure about restructuring reserves, R&D write-offs, and similar items.

By now it should be very clear that basic accounting knowledge is a valuable skill to have, whether you start your own company or work for someone else. Analyzing a company’s financial statements before you take a job there can tell you quite a bit about its financial health. Once you are on the job, you need to understand how to read financial statements and how to develop financial information for business operations. It’s almost impossible to operate effectively in a business environment otherwise….

and reporting a firm’s financial activities according to a standard set of procedures. The financial reports resulting from the accounting process give managers, employees, investors, customers, suppliers, creditors, and government agencies a way to analyze a company’s past, current, and future performance. Financial accounting is concerned with the preparation of financial reports using generally accepted accounting principles. Managerial accounting provides financial information that management can use to make decisions about the firm’s operations.

Public accountants work for independent firms that provide accounting services—such as financial report preparation and auditing, tax return preparation, and management consulting—to other organizations on a fee basis. Private accountants are employed to serve one particular organization and may prepare financial statements, tax returns, and management reports.

statements. It begins with analyzing business transactions, recording them in journals, and posting them in ledgers. Ledger totals are then summarized in a trial balance that confirms the accuracy of the figures. Next the accountant prepares the financial statements and reports. The final step involves analyzing these reports and making decisions.

The balance sheet represents the financial condition of a firm at one moment in time, in terms of assets, liabilities, and owners’ equity. The key categories of assets are current assets, fixed assets, and intangible assets. Liabilities are divided into current and long-term liabilities. Owners’ equity, the amount of the owners’ investment in the firm after all liabilities have been paid, is the third major category.

some period. The main parts of the statement are revenues (gross and net sales), cost of goods sold, operating expenses (selling and general administrative expenses), taxes and net profit or loss.

of cash during a financial reporting period. It breaks the firm’s cash flows into those from operating, investment, and financing activities. It shows the net change during the period in the firm’s cash and marketable securities.

a firm’s operations, profitability, and overall financial condition. The four main types of ratios are liquidity ratios, profitability ratios, activity ratios, and debt ratios. Comparing a firm’s ratios over several years and comparing them to ratios of other firms in the same industry or to industry averages can indicate trends and highlight financial strengths and weaknesses.

technology in several ways. The role of accountants has expanded beyond the traditional audit and tax functions and now includes management consulting in areas such as computer systems, human resources, and electronic commerce . A major issue facing the industry is how to treat key intangible assets—knowledge assets such as patents, brands, research and development—and whether they should be valued and included on a company’s balance sheet. In addition, both the FASB and the SEC have raised concerns about the quality of reported earnings. Loose interpretation of GAAP has given companies leeway in how they deal with items like restructuring charges and write-offs resulting from acquisitions.