1. Unit 1 Outline Module 1: Innovations and Entrepreneurs Module 2: Small Business Module 3: Marketing Module 4: Accounting

2. Module 4 Accounting 3. Cash Accounting 1. Role of Accounting 2. Accounting Equation 4. Cash Budget 5. Sales Forecast

3. Session 1: Role of accounting Define accounting, financial data, financial information, source documents, recording, reporting, and advice. Explain why accounting is important for businesses.

4. Why is accounting important? Business is not just about making and selling; it is about managing – managing people, managing stock, managing customers and suppliers – and, last but not least, managing cash. If a business owner is to manage their business effectively, then they will need accurate information that can be relied upon to assist them in the decisions they make. The purpose of accounting then is to provide business owners with financial information that will assist them in making decisions about the activities of their firm.

5. What is accounting? Accounting is the collection, recording and reporting of financial information to assist business owners in decision- making

6. Financial data and financial information Financial Data raw facts and figures upon which financial information is based Financial Information financial data which has been sorted, classified and summarised into a more usable and understandable form Accounting is about providing info; but that info has to come from a source and actually begins its life as raw facts (source documents) before being transformed into a form that is useful for decision-making (financial reports). Therefore we need to distinguish between financial data and financial information.

7. What are the 4 stages of the accounting process? Source Documents RecordReport Provide Advice The process of turning financial data into financial information is facilitated by what is known as the accounting process.

8. Accounting Process Stage 1: Collect source documents Business collects the source documents relating to its transactions. Source documents are the pieces of paper that provide both the evidence that a transaction has occurred, and the details of the transaction itself. Examples include: Receipts, provide evidence of cash received by the business Cheque butts, provide evidence of cash paid by the business Invoices, provide evidence of credit transactions Memos, provide evidence of transactions within the firm itself

9. Accounting Process Stage 2: Recording Recording involves sorting, classifying and summarising the information contained in the source documents so that it is more usable. Common accounting records include: journals, which record daily transactions of a common type (such as all cash paid, all cash received, or all stock purchased on credit) stock cards, which record all the movements of stock in and out of the business.

10. Accounting Process Stage 3: Reporting Reporting involves the preparation of financial statements that communicate financial information to the owner, so that decisions can be made. There are three general-purpose reports that all businesses should prepare: a Statement of Receipts and Payments to report on the cash the firm has received and paid, and the change in its bank balance over a period an Income Statement to report on the firm’s revenues and expenses over a period a Balance Sheet to report on the firm’s assets and liabilities at a particular point in time.

11. Accounting Process Stage 4: Advice Advice is the provision to the owner of a range of options appropriate to their aims/objectives, and recommendations as to their suitability. This is where the real skill of an accountant comes into play! Without proper advice, the information in the reports is as good as useless, but if the reports are explained carefully and the accountant provides the owner with a range of options, a more informed decision – and a better outcome for the business – should occur.

12. Practice Exam Questions 1. Reorder the following stages of the accounting process: recording transactions in journals and stock cards collecting source documents like receipts and cheque butts providing advice to the owner of the business preparing financial reports. 2. Identify which stage of the accounting process is performed by each of the following actions: preparing an Income Statement filing sales invoices entering transactions in a cash journal presenting the owner with alternative sources of finance.

13. APs vs QCs APs Accounting principles are the generally accepted rules governing the way accounting information is recorded QCs Qualitative characteristics are the qualities we would like our accounting reports to possess, and include. MCCHERG Red Rooster’s Ugly Chickens

14. Accounting Principles Monetary Unit – all items must be recorded and reported in a common unit of measurement; that is, Australian dollars Consistency – accounting methods should be applied in a consistent manner to ensure that reports are comparable between periods Conservatism – losses should be recorded when probable but gains should only be recorded when certain. This is so liabilities and expenses are not understated and assets and revenues are not overstated.

15. Accounting Principles Historical Cost – the recording of a transaction at its original cost or value, as this value is verifiable by reference to the source document Entity – the business is assumed to be separate from the owner and other businesses, and its records should be kept on this basis Reporting Period – the life of the business must be divided into periods of time to allow reports to be prepared Going Concern – the life of the business is assumed to be continuous, and its records are kept on that basis.

16. Qualitative Characteristics Relevance - Reports should include all information that is useful for decision-making. Reliability - Reports should contain information verified by source document evidence so that it is free from bias. Understandability - Reports should be presented in a manner that makes it easy for the user to comprehend their meaning. Comparability - Reports should be able to be matched up to each other over time through the use of consistent accounting procedures.

17. Activity Complete the AP and QC mix and match!

18. Session 2: Accounting equation Describe the accounting equation. Identify and define assets, liabilities and owners’ equity. Explain the relationship between elements of the accounting equation. Calculate owner’s equity using the accounting equation.

19. Accounting Elements These are absolutely critical to understand. If you misclassify something, you will record it incorrectly, which will throw out your reports and render your results incorrect. Each element has particular ‘criteria’ to be met to be classified as a given element.

20. Accounting Elements 5 Accounting Elements: Assets Liabilities Owner’s Equity Revenues Expenses For now, we will focus of A, L + OE

21. 1. Assets Asset = a resource controlled by an entity, as a result of a past event, that is expected to provide a future economic benefit to the entity. For an item to be recognised as an asset, it must meet all parts of the definition: 1.Resources 2.Control 3.Future economic benefits

22. 1. Assets RESOURCE = items capable of generating economic gain for a business. What are some examples of resources?  Bank (cash held there, not the building)  Stock  Vehicles  Premises

23. 1. Assets CONTROL = firm must be in a position to determine how and when the item is used. This is NOT NECESSARILY the same as owning something. Control is broader (so it includes, but is not restricted to, what the firm owns) What is an example of something NOT under the firm’s control?

24. 1. Assets What is an example of something NOT under the firm’s control?  The business owner’s home cannot be classified as a business asset because it is not under business control.  This is where the ENTITY principle comes into play!

25. APs vs QCs APs Accounting principles are the generally accepted rules governing the way accounting information is recorded QCs Qualitative characteristics are the qualities we would like our accounting reports to possess, and include. MCCHERG Red Rooster’s Ugly Chickens

26. APs The entity principle states that the BUSINESS is separate from its OWNER. Essentially, if you own a business, those records are kept separate to your own personal records.

27. 1. Assets FUTURE ECONOMIC BENEFIT = some sort of benefit that is yet to be received. Think-pair-share: Which principle does this relate to?  Going Concern principle Example:  Cash in the bank = asset  b/c it can be spent at some point in the future.  Cash paid for this month’s wages ≠ asset  b/c there is no future benefit (the benefit has already been received).

28. 2. Liabilities Liability = Future sacrifice in economic benefits (outflow) that the organisation has the present obligation to make. For an item to be recognised as a liability, it must meet all parts of the definition: 1.Future sacrifice in economic benefits 2.Present obligations

29. 2. Liabilities Future sacrifice in economic benefits (outflow) FUTURE = the sacrifice has not yet occurred, but the liability is “expected to result in” this sacrifice. SACRIFICE / OUTFLOW = giving up something for the sake of something else. ECONOMIC BENEFITS = usually a future cash payment, but not necessarily (eg. unearned accounts)

30. 2. Liabilities So, what does a future sacrifice / outflow in economic benefits actually look like? Cash as the economic benefit Eg. cash, the expected outflow (sacrifice) occurs when Luke’s Tournament Masters pays its debts. Non-cash economic benefit Luke’s Tournament Masters has just received cash in advance for a job (a summer riding camp) which will not occur for another 2 weeks. It is not a cash payment that is required to extinguish this liability, it is the completion of work.

31. 2. Liabilities PRESENT OBLIGATION = a legal responsibility (obligation) to settle a debt. Debt = something (money, goods or services) owed to someone else. If Luke’s Tournament Masters has a legal obligation to settle a debt, it is very likely that this debt is a liability. Think about it … if a business has a present obligation to settle a debt then they will likely have to make a future sacrifice of economics benefits in order to settle this debt.

32. 2. Liabilities What does a present obligation look like?  Demi’s Beauty Studio has a mortgage on the premises of the recording studio.  The contract with the bank means that Demi’s Beauty Studio is obligated to repay the bank the amount owing on the premises.

33. 2. Liabilities What is not a present obligation?  Demi’s business expects to pay for advertising in 2015.  This cannot be reported as a liability b/c right now there is no obligation to pay for the ads.  The obligation only occurs once the firm has signed a contract or the advertising itself has been provided.

34. Recall Assets = resources controlled by an entity, from which future economic benefits will flow to the entity. Liabilities = present obligations of the entity, the settlement of which is expected to result in an outflow of resources embodying economic benefits.

35. Activity 1.Research and provide a definition for each of the following items  Classify the items as an asset or a liability Creditors Equipment Bank overdraft Vehicle Furniture Stock of supplies Mortgage Cash at bank Debtors Loan Premises

36. Activity: Answers ASSETS Stock of supplies Cash at bank Debtors Premises Equipment Vehicle Furniture LIABILITES Mortgage Bank overdraft Creditors Loan

37. 3. Owner’s Equity Owner’s Equity = the Residual Interest in the assets of the entity after deducting liabilities How else can we think of this concept? 3 ways:  What’s left over for the owner once the firm has met all its obligations (liabilities).  The amount the business ‘owes the owner’  Owner’s equity = Assets – Liabilities

38. 3. Owner’s Equity  So, owner’s equity is the amount the business ‘owes the owner’. How can a business owe its owner?  Think-pair-share: What principle does this relate to?  Recall the entity principle – the business and the owner are separate. So, the assets and liabilities of the firm are not the owner’s they are the firm’s.  BUT assets > liabilities (b/c of the accounting equation), so there must be something left over! This left over (i.e. residual) is what the firm owes to the owner.

39. The accounting equation Both LIABILITIES and OE represent CLAIMS on the ASSETS of the business Liabilities are what the business owes to external parties OE is what the business ‘owes’ the owner This relationship between assets, liabilities and owners equity is what is described as the ACCOUNTING EQUATION.

40. The Accounting Equation ALOE A beautiful (and easy) thing about Accounting is that the Accounting Equation must always balance.

41. The Accounting Equation A = $100,000 L = $60,000 OE = $10,000 Why does it have to balance? Consider this … We have $30,000 leftover. This means $30,000 has not been claimed by liabilities or the owner! It is not possible for an amount to remain unclaimed.

42. The Accounting Equation Assets = $100,000 Liabilities = $60,000 OE = $40,000 Who would be entitled to the unclaimed amount? The owner! So, owner’s equity would have to be $40,000 not $10,000.

43. Activity For each of the following examples, use the accounting equation to calculate the value of owner’s equity: 1.Mark’s Dog Washing Service has $4500 in assets, but owes $500 to the local newspaper for advertising. 2.Bianca owns and operates Bianca for Hair. The firm has $5 600 in assets, but owes a supplier $250.

44. Activity 1: Answers Mark’s Dog Washing Service has $4500 in assets, but owes $500 to the local newspaper for advertising.

45. Activity 2: Answers Bianca owns and operates Bianca for Hair. The firm has $5 600 in assets, but owes a supplier $250.

46. Activity For each of the following examples, use the accounting equation to calculate the value of owner’s equity: 3.Andrew is the owner of an accounting firm. He owns a car worth $1 500, a stereo worth $800, clothing worth $750 and other assets worth $1 000. His firm owns office equipment worth $15 000 and a vehicle worth $20 000, but owes $600 to an employee. 4.Sasha Enterprises has $4 500 in the bank, but owes $1 000 on a loan it took out to buy equipment. The equipment is worth $1 500, and a company car is worth $17 000. A client still owes $500 for work done by the firm, and Sasha owes $150 on her Visa card.

47. Activity 3: Answers Andrew is the owner of an accounting firm. He owns a car worth $1 500, a stereo worth $800, clothing worth $750 and other assets worth $1 000. His firm owns office equipment worth $15 000 and a vehicle worth $20 000, but owes $600 to an employee.

48. Activity 4: Answers Sasha Enterprises has $4 500 in the bank, but owes $1 000 on a loan it took out to buy equipment. The equipment is worth $1 500, and a company car is worth $17 000. A client still owes $500 for work done by the firm, and Sasha owes $150 on her Visa card.

49. Activity For each of the following examples, use the accounting equation to calculate the value of the assets. 1.John knows that his equity in his firm is $3000, and that his firm owes $600 to a supplier. 2.Ella has equity of $10 000 in her business, and has $5 000 worth of personal assets. She owes Branko $500, and the firm has debts of $3 000.

50. Activity 1: Answers John knows that his equity in his firm is $3 000, and that his firm owes $600 to a supplier.

51. Activity 2: Answers Ella has equity of $10 000 in her business, and has $5 000 worth of personal assets. She owes Branko $500, and the firm has debts of $3 000.

52. The Balance Sheet Balance Sheet = accounting report that details the first three accounting elements – ASSETS, LIABILITIES and OWNER’S EQUITY It is a reflection of the firm’s accounting equation Memory Tool  the accounting equation must balance on the balance sheet

53. The Balance Sheet The balance sheet is a financial report that represents the firm’s POSITION (with respect to A, L and OE) AT a particular point in time Also known as the Statement of Financial POSITION

54. How the Accounting Equation looks in the Balance Sheet Assets = Liabilities + Owner’s Equity Current Assets Non-Current Assets TOTAL ASSETS Current Liabilities Non-Current Liabilities + Owner’s Equity TOTAL LIABILITIES & EQUITY

55. What do we notice about the Balance Sheet? Assets = Current Assets Non-Current Assets TOTAL ASSETS Current Liabilities Non-Current Liabilities + Owner’s Equity TOTAL LIABILITIES & EQUITY Liabilities + Owner’s Equity The assets are listed on the left-hand side and the equities (L + OE) are listed on the right, just like in the accounting equation.

56. Current vs. Non Current Assets and Liabilities can be further classified into Current and Non-Current. Determined by a 12 month test.

57. Current vs. Non Current ASSETS CURRENT ASSET = those assets that are expected to be consumed within 12 months (i.e. asset provides an economic benefit only in the next 12 months). NON CURRENT ASSET = those assets that are expected to provide economic benefits for more than 12 months.

58. Current vs. Non Current LIABILITIES CURRENT LIABILITIES = those liabilities that are expected to be settled within 12 months. NON CURRENT LIABILITIES = those liabilities that are expected to be settled after 12 months.

59. Task: Classification of accounting elements Cash in bank Creditors Loans due in next 12 months Mortgage (this year) Debtors Premises Vehicles Classify each of the following items as a current asset, non-current asset, current liability or non-current liability Mortgage (remainder) Stock of supplies Wages owing to employees Loans due in next 12 months Bank overdraft Equipment Shop fittings

60. Task: Answers AssetsLiabilities CurrentNCCurrentNC Cash in bank Stock of supplies Debtors Premises Vehicles Shop fittings Equipme nt Creditors Wages owing to employees Loans due in next 12 months Mortgage (this year) Bank overdraft (not b/c it will be met in the next 12 months but b/c it can be) Longer- term loans Mortgage (remaind er)

61. A closer look at loans Some of the amount owing on the loan may be current and some non-current. Example: Brittany has a mortgage on the building premises for his business Brittany’s Art Studios. The Bank expects Brittany to make gradual repayments off the principal rather than repay one ginormous amount at the end of the loan. Here, the amount of Brittany’s loan due for repayment in the next 12 months = current liability. The remainder (which is due after 12 months) = non- current liability.

62. How does this look on the balance sheet? Current Assets$$Current Liabilities$$ Bank 5,000 Creditors 6,000 Stock 34,000 Loan – ANZ Bank 12,00018,000 Debtors 12,00051,000 Non-Current Liabilities Non-Current Assets Loan – ANZ Bank 24,000 Vehicles 45,000 Owner’s Equity Capital - Brittany 54,000 Total Assets 96,000 Total Equities 96,000 BRITTANY’S ART STUDIOS Balance Sheet as at 30 January 2014

63. Task Complete the Classified Balance Sheet worksheet

64. Double Entry Accounting Every business has transactions. These transactions have to be stored somewhere to prove they have occurred (apart from simply keeping the source documents). Regardless of the nature of the business transaction, there will always be TWO items affected in the firm’s accounting equation and therefore its Balance Sheet  Hence, the name DOUBLE entry.

65. Double Entry Accounting rules Two rules: 1.Every transaction will affect at least two items in the accounting equation. 2.After recording these changes, the accounting equation must still balance. Because the Balance Sheet is based on the accounting equation, the same two rules of double-entry accounting also apply to the Balance Sheet.

66. Double Entry Accounting But why are there two entries? Essentially, ‘every action has a reaction’ so that this equation constantly balances. ASSET S LIABILI TIES OE

67. Double Entry Accounting TransactionFirst EffectSecond Effect Owner deposited $80,000 to commence business  cash at bank (asset) by $80,000  capital (owner’s equity) by $80,000

68. Double Entry Accounting TransactionFirst EffectSecond Effect Took out an interest- only loan $20,000  cash at bank (asset) by $20,000  loan (liability) by $20,000

69. Double Entry Accounting Transaction Bought shop fittings for cash $10,000 + GST of $1,000 First Effect  shop fittings (asset) by $10,000  GST liability by $1,000 Second Effect  cash at bank (asset) by $11,000

70. Double Entry Accounting Transaction Purchased stock on credit for $15,000 + GST of $1,500 First Effect  Stock (asset) by $15,000  GST liability by$1,500 Second Effect  Creditors (liability) by $16,500

71. Double Entry Accounting Transaction Sold goods for $2,000 cash + GST of $200 (cost price of goods sold $1,200) First Effect  Cash at bank (asset) by $2,200  Stock (asset) by $1,200  Total overall increase in assets $1,000 Second Effect  GST liability by $200 (*)  Capital (OE) by $800 (**)  Total increase $1,000 * B/c the business collected $200 on its sale on behalf of the government. ** B/c Profit = Revenue (2000) – Expenses (1200) = $800

72. Double Entry Accounting Transaction Paid wages for the week $500 First Effect  Cash at bank (asset) by $500 Second Effect  Capital (OE) by $500, as wages is an expense

73. DOUBLE ENTRY ACCOUNTING Memory Tool: Revenue items   OE Expense items   OE

74. DOUBLE ENTRY ACCOUNTING 2 Rules: 1.Every transaction will affect at least two items in the accounting equation. 1.After recording these changes, the accounting equation must still balance.

75. Session 3: Cash Accounting Learning intentions: Explain the operation of a single-entry accounting system to account for cash. Record transactions in cash journals, including GST

76. SYSTEMS OF ACCOUNTING Single Entry An accounting system which records only a single journal entry for each transaction, meaning that only the personal and cash aspects of transaction are recorded. Suitable for very small, cash-based businesses. Double Entry An accounting system which requires both a debit and a credit entry for each transaction, so that the accounting equation balances. Suitable for most businesses.

77. Service Businesses Service businesses operate by providing their time, labour or expertise (or a combination of all three) in return for a fee or charge M ost of these transactions are for cash. Hence, a single-entry accounting system is appropriate for small service businesses!

78. Service Businesses ‘Cash’ includes notes and coins, cheques, and the balance of the firm’s bank account

79. Cash Recording The accounting system must be able to generate information relating to the firm’s cash position, including: Cash Receipts = Amount of cash business has received from other entities during the reporting period. Verified by receipts, cash register rolls and the Bank Statement. Cash Payment = Amount of cash the business has paid to other entities during the reporting period Verified by cheque butts and the Bank Statement. Bank Balance = Level of cash on hand at a particular point in time. Verified by the Bank Statement.

80. ACCOUNTING PROCESS Source Documents RecordsReportsAdvice Once the relevant source documents have been collected and sorted, it is necessary to record the data in journals. Recording = writing down raw financial data from source documents in an organised format, so that it becomes financial information that can be presented in accounting reports

81. ACCOUNTING PROCESS: Recording Journal = accounting record in which transactions are written down in an organised format (e.g. a ruled book) Cash transactions are recorded in one of two journals: Cash Receipts Journal = journal summarising all cash received by the business during a particular reporting period. Cash Payments Journal = journal that summarises all cash paid by the business during a particular reporting period.

82. ACCOUNTING PROCESS: Recording Frequent transactions are recorded in their own classification column Infrequent transactions are recorded in the sundries column

83. CASH RECEIPTS JOURNAL Each receipt must be recorded twice: 1.Bank column (records cash received) 2.Classification column (records source of the cash) Details that must be recorded in the Cash Receipts Journal: 1.Date of transaction 2.Details of transaction 3.Receipt Number 4.Bank = amount of cash received 5.Classification Columns = any frequent receipts (e.g. painting fees for a paint shop) 6.Sundries = any infrequent receipts (e.g. capital contribution)

84. ACCOUNTING PROCESS: Recording Double-checking mechanism At the end of the reporting period, each column in the Cash Receipts Journal should be totalled Total of Bank Sum of totals of all the other columns (i.e. classification + sundries

85. CASH PAYMENTS JOURNAL Each receipt must be recorded twice: 1.Bank column (records cash received) 2.Classification column (records source of the cash) Details that must be recorded in the Cash Receipts Journal: 1.Date of transaction 2.Details of transaction 3.Cheque Number 4.Bank = amount of cash paid 5.Classification Columns = any frequent receipts (e.g. wages, drawings) 6.Sundries = any infrequent receipts (e.g. purchase of vehicle)

86. ACCOUNTING PROCESS: Recording Double-checking mechanism At the end of the reporting period, each column in the Cash Payments Journal should be totalled Total of Bank Sum of totals of all the other columns (i.e. classification + sundries

87. ACCOUNTING PROCESS: reporting Cash transactions are reported in the Statement of Receipts and Payments. Statement of Receipts and Payments = an accounting report that shows the firm’s cash receipts and payments and the consequent change in its bank balance over a reporting period.

88. ACCOUNTING PROCESS: reporting The Cash Receipts and Cash Payments Journals do not provide a comprehensive assessment of the firm’s cash situation because they do not show … The firm’s bank balance at the start of the period The firm’s bank balance at the end of the period The overall change (increase or decrease) in the firm’s bank balance. So, we need to take the info contained in the cash journals and present it in an understandable form via the Statement of Receipts and Payments

89. ACCOUNTING PROCESS: reporting Gogh’ Painting Service Statement of Receipts and Payments for March 2016 $$ Cash Receipts Less Cash Payments Cash Surplus (deficit) add Opening Bank Balance Closing Bank Balance

90. ACCOUNTING PROCESS: reporting ItemDescription Cash Receipts Totals of classification columns and individual amounts from sundries columns, including GST Less Cash Payments Cash Surplus (deficit) Overall change in firm’s bank balance (Surplus or Deficit = Cash Receipts – Cash Payments) add Opening Bank Balance How much cash was in the firm’s bank account at the start of the reporting period Closing Bank Balance How much cash was in the firm’s bank account at the end of the reporting period (i.e. now) This gets reported as Bank in the next Balance Sheet.

91. Cash surplus vs cash deficit Cash surplus – will lead to an increase in the bank balance Cash deficit – will lead to a decrease in the bank balance But, a cash deficit does not mean a negative bank balance! Bank overdraft = negative bank balance (current liability) Bank = positive bank balance (current asset)

92. Uses of the statement of receipts and payments Useful for decision-making because it summarises all the information relating to the firm’s cash position. Help the owner make decisions about the firm’s: Cash receipts; Cash payments; and Level of cash on hand. A high bank balance means the owner may wish to use the excess cash to pay off loans, take extra drawings or purchase newer non-current assets. A low bank balance means the owner may need to make lower loan repayments, lower drawings, use credit for some purchases, or perhaps make a capital contribution.

93. The GST GST received on fees creates a GST liability GST paid to suppliers reduces that liability

94. The GST If GST received is greater than GST paid, the business will have a GST liability, and a GST settlement will be required If GST paid is greater than GST received, the business will have a GST asset, and a GST refund will be due. As selling prices are generally higher than cost prices, most firms will end up with a GST liability

95. The GST As selling prices are generally higher than cost prices, most firms will end up with a GST liability

96. Session 4: Sources of Finances Learning intentions: Distinguish between internal and external sources of finance Describe the various forms of finance available to small businesses

97. Internal and External Sources of Finance The accounting equation identified that the assets of a business are funded from one of two sources: 1.Internal sources of finance (owner’s equity) This could be in the form of a capital contribution or using previously generated profits. However, as a start-up you will not have any retained profits. 2.External sources of finance (liabilities) Bank overdraft (bank that allows the account holder to withdraw more than their current account balance) Term Loan (a form of external finance provided by banks and other lenders for a specific purpose and repaid over time, such as a mortgage or a general bank loan)

98. Option 1: Capital Contribution Advantages: no set repayment date no interest charge. Disadvantages: limited to the resources of the owner.

99. Option 2: Bank overdraft Advantages: readily accessible flexible – can be used for a variety of purposes. Disadvantages: high interest charge can be recalled at short notice.

100. Option 3: Term Loan Advantages: makes possible the purchase of expensive assets flexible – can be used for a variety of purposes secured loans attract a lower interest rate. Disadvantages: interest charges requires commitment by business to make repayments for the term of the loan principal and interest repayments can put pressure on cash flows.

101. Why do you need internal or external finance? Startup costs for a new business can be significant. Without an initial source of finance the business would be unable to purchase assets needed to start the business in the first place! Example start up costs: Computer Computer software Printer Mobile phone Equipment Tools Uniforms Electricity Telephone bill Internet connection Rent Advertising material (flyers, business cards) Fees for website designer Fees for graphic design agency Insurance Accountant Wages Recruitment costs / fees

102. Session 5: Budgets Learning intentions: Define budgeting Distinguish between budgeted and actual reports Prepare budgeted reports for cash and profit

103. What is budgeting? There is a saying in business circles that ‘failing to plan is planning to fail’. At its heart is the idea that a business cannot be successful if it does not prepare early for what it may face in the future. Budgeting is the process of preparing reports that estimate or predict the financial consequences of likely future transactions.

104. What is budgeting? Budgets are different from normal accounting reports in two main ways: Budgets report future events rather than historical events; they focus on what might happen rather than what has already happened. As a consequence, budgets use estimates or predictions rather than actual, verifiable data.

105. Purpose of budgeting Like all accounting reports, budgeted reports have a role in both planning and decision- making: Budgeting assists planning by predicting what is likely to occur in the future. Budgeting aids decision-making by providing a standard (a benchmark or yardstick) against which actual performance can be measured.

106. The budgeting process

107. The Cash Budget In order to survive into the future, a small business must have sufficient cash to meet its obligations. The Cash Budget attempts to estimate all future cash receipts and payments, and thus predict the firm’s cash balance at the end of the budgeted period. The Cash Budget is an accounting report which predicts future cash receipts and payments, determines the expected cash surplus or deficit, and thus estimates the bank balance at the end of the budget period.

108. Cash Budget What report does this sound similar to? The Statement of Receipts and Payments! In fact, the headings are identical! The only differences are those outlined earlier: rather than actual historical data, the Cash Budget uses estimates of future transactions. The only actual figure in the Cash Budget is the bank balance at start (as this figure is already known when the budget is prepared).

109. Cash Budget Expected Cash Receipts Cash Fees/takings GST received GST refund Other revenue received (e.g. interest revenue) Cash contributions by the owner Loans received Cash received from the sale of a non-current asset. Expected Cash Payments Expenses paid (e.g. wages, rent or advertising) GST paid GST settlement Cash drawings by the owner Loan repayments Cash paid for non-current assets.

110. Example: Perfect Portraits How can the budget be used for planning? The owner could prepare for a cash deficit by: increasing advertising; changing prices; or offering other services in order to increase Cash Fees making a cash capital contribution reducing cash payments for expenses (but not necessarily advertising or wages … why not?) deferring the purchase of non-current assets, or using credit facilities or a loan for their purchase deferring loan repayments (on existing loans) taking less cash drawings organising (or extending) an overdraft facility.

111. Example: Perfect Portraits How can the budget be used for planning? The owner could prepare for a cash surplus by using the extra cash to: purchase more or newer non-current assets increase loan repayments increase cash drawings expand operating activities by increasing advertising, employing more staff etc. For example, Perfect Portraits predicted a cash surplus of $12 540, so the owner can start planning how this extra cash can be used. The owner had already made plans to use $10 000 to contribute to the purchase of a company car later in the year.

112. Example: Perfect Portraits How can the budget be used for decision-making? The Cash Budget sets a standard (a target or benchmark) that can be used to assess actual cash receipts and payments. By comparing actual cash flows against the budgeted figures, the owner can identify problems areas (where performance was below expectation), and then act to correct the situation. Examples: PP set a target for Cash Fees of $16 000: should actual Cash Fees not meet this expectation, corrective action (in the form of more/better advertising, or a review of prices) can be taken. Should payments for Photographic Supplies exceed the budgeted figure of $7 000, the owner may wish to review handling procedures, or even change suppliers (for a cheaper price).

113. Cash Budgets in Consecutive Periods In general, more frequent budgets will be more accurate, and therefore more useful as benchmarks for comparison. To show the effect of monthly variations it would be wise for a business to prepare budgets for consecutive months. That is, separate budgets for October, November and December 2016 could be prepared and presented side-by-side to show trends in receipts and payments from month to month.

114. Cash Budgets in Consecutive Periods

115. Sales Forecast A sales forecast shows the level of sales revenue in a future reporting period based on the expected selling price and number of sales. Sales might be expected to increase steadily over time or they could be cyclical. For example, a book store will likely sell many more books in Nov-Dec because of Christmas.

116. Sales Forecast Example: Harriet’s Hats is a new hat store opening in Jan 2016. Harriet expects that sales will steadily increase throughout the first year of operation. However, she expects a spike in October. Why? What will happen after the spike? 2016JFMAMJJASOND Number of sales1710152025303545905060 Selling Price120 Revenue12084012001800240030003600420054001080060007200

117. Sales Forecast What has Harriet assumed in her prediction? Very few sales in the first month of operation Steady increase of approximately 5 clients thereafter. Big spike during racing season due to high demand for hats. Slightly higher demand in December due to Christmas and summer (high sun exposure) 2016JFMAMJJASOND Number of sales1710152025303545905060 Selling Price120 Revenue12084012001800240030003600420054001080060007200