5 Financial Planning Why should a business do financial planning? Reduces financial uncertaintiesIncreases control of financial activitiesProvides a ‘map of finances’ for businessMakes it easier to ‘stick’ to financial processes and goals.
6 Financial Planning continued Phases of businessStart-upFinancial planning includes determining the amount of money needed to start and operate the business until a profit is made. Also the major sales and expenses are determined.OperationFinancial planning includes determining whether they are making enough money to operate. The basic formula used is Revenue – Expenses = Profit or Loss.ExpansionFinancial planning includes determining whether enough money is made to cover growth opportunities.
8 Business Budgets Types of business budgets: Start-up budget used by a new business or during expansion of a business until profits are made.Operating budget used for ongoing business operations for a specific period.Cash budget used to estimate cash flow in and out of a business.
9 Business Budgets continued Steps for preparing a business budget:Prepare a list of income and expense items.Gather accurate information from business records.Create the budget.Clearly communicate the budget to key employees in order to make sound business decisions.
10 What is income? Money received for goods or services Net Sales Revenue ReceiptsEarningsInterest
11 What is expense? Cost or charge incurred; a payment of money Salaries AdvertisingUtilities TelephoneRent Repairs/MaintenanceInsurance Taxes
12 Sample Company Budget January 1, xxxx to December 31, xxxx CategoryActualBudgetDifferenceInflowsNet Sales385,400300,00085,400Cost of Goods Merchandise Inventory, January 1160,000 Purchases120,00090,00030,000 Freight Charges 2,500 2,000 500 Total Merchandise Handled282,500252,00030,500 Less Inventory, December 31100,000(20,000) Cost of Goods Sold182,500132,00050,500 Gross Profit202,900168,00034,900Interest Income 500 700 (200)Total Income202,500168,70033,800ExpensesSalaries68,25045,00023,250Utilities5,8004,5001,300Rent23,000Office Supplies2,2503,000(750)Insurance3,900Advertising8,6509,000(350)Telephone2,7002,300400Travel and Entertainment2,5502,000550Dues & Subscriptions1,1001,000100Interest Paid2,1402,500(360)Repairs & Maintenance1,250250Taxes & Licenses11,70010,0001,700Total Expenses133,290106,85026,440Net Income$69,210$61,850$7,360
13 Startup Budget March 17, 2011 Cash Needed % of Actual Cash to Start Actual Cashto StartTotalSpentVarianceMonthly CostsSalary of owner-manager$6,00013.7%$6,50013.9%($500)15.8%All other salaries and wages7,00016.0%7,10015.1%(100)3.2%Rent1,0002.3%9001.9%100-3.2%Advertising2,0004.6%4.3%Delivery expense4000.9%2.1%(600)19.0%Supplies5001.1%1,500(1,000)31.6%TelephoneOther utilities7601.6%(260)8.2%Insurance6001.4%1.3%Taxes, including social securityInterestMaintenance3000.7%0.6%Legal and other professional fees3,0006.9%3,3007.0%(300)9.5%MiscellaneousSubtotal$23,80054.4%$26,46056.4%($2,660)84.2%One-Time CostsFixtures and Equipment$10,00022.9%$11,00023.4%($1,000)Decorating and remodeling1,2002.6%(200)6.3%Installation chargesStarting inventory5,00011.4%4,0008.5%-31.6%Deposits with public utilitiesLicenses and permitsAdvertising and promotion for openingCash7501.7%Other2000.5%0.4%$19,95045.6%$20,45043.6%Totals$43,750100%$46,910($3,160)
14 SAMPLE Operating Budget July 1, 2004 to June 30, 2005IncomeMembership dues - $ $875.00Fund-raiser $100.00Contest entry award $25.00Aluminum can sales $27.00T-shirt sales $468.00Parties $200.00Total Income $1,695.00ExpensesParties $710.00Intramurals $15.00Gifts $55.00Refreshments $100.00National/regional dues $175.00Fund-raiser $44.00T-shirts $450.00Picnic $99.00Office supplies/duplicating $28.00State & County sales tax $19.00Total Expenses $1,695.00AVAILABLE FUNDS
16 Financial Records and Statements What is the purpose of financial records?Financial records provide specific information about business activities that is used to analyze the financial performance of a business.What is the purpose of financial records?Financial records provide specific information about business activities that is used to analyze the financial performance of a business.
17 Financial Records and Statements Financial records used by businesses:Asset records – buildings and equipment owned by the business, their original and current value, and the amount owed if money is borrowed to purchase the assetsDepreciation records – identify the amount assets have decreased in value due to their age and useInventory records – identify the type and number of products on hand for sale; help determine # products sold, damaged or lost and the current value of that inventory
18 Financial Records and Statements Records of accounts – identify all purchases and sales made using creditAccounts payable record identifies the companies from which credit purchases were made and the amount purchased, paid and owed.Accounts receivable record identifies customers that made purchases using credit and the status of each accountCash records – list all cash received and spent by the business
19 Financial Records and Statements Payroll records – contain information on all employees of the company, their compensation and benefits.Tax records – show all taxes collected, owed and paid. As a part of payroll, employers must withhold a certain percentage of employees’ salaries and wages for federal income tax. The company also makes payments for Social Security and Medicare and, in some cases, for unemployment compensation insurance. Businesses may have to pay several types of taxes on their income and value of their assets.
20 What are assets? Assets are things that a business (or person) owns Examples: cash, inventory, real estate, equipment, accounts receivable
21 What are liabilities?Liabilities are things that a business (or person) owesExamples: debt, accounts payable, loans
22 What is owner’s equity?Owner’s equity is the value of the owners’ investment in the businessValue of business after liabilities are subtracted from assets
23 Financial Records and Statements continued What are financial statements?Financial statements provide a picture of the financial performance of a businessWhat are financial statements?Financial statements provide a picture of the financial performance of a business.What is the difference between a balance sheet and an income statement?A balance sheet includes assets, liabilities, and owner’s equity. An income statement includes sales, expenses, and net profit or loss.
24 Financial Records and Statements continued What is the difference between a balance sheet and an income statement?Balance sheet includes assets, liabilities and owner’s equityIncome statement includes sales, expenses and net profit/net loss
25 Revenue vs. ExpensesRevenue is all income received by the business during the period. Sources of income include the sale of products and services, plus interest earned from investments.Expenses are all the costs incurred by the business during the period. Expenses include operations, purchase of equipment, supplies, inventory, payroll and taxes.
26 Revenue vs. ExpensesThe business has net income when revenue is greater than expenses.The business has net loss when expenses are greater than revenue.
30 Financial Performance Ratios Financial performance ratios are comparisons using a company’s financial data to determine how well a business is performing.The four main types of financial ratios:Current ratioDebt to equity ratioReturn on equity ratioNet income ratio
31 Financial Performance Ratios continued Current ratioEquals current assets/current liabilitiesRepresents assets that the business could convert into cash in < 1 year compared to liabilities that it must pay in < 1 year; shows ability of company to pay debts as they become due. Ideally, this ratio should be over 1.0.Normally, the higher the ratio, the more favorable it is for the company.
32 Financial Performance Ratios continued Debit to equity ratioEquals total liabilities/owner’s equityShows how much the business relies on money borrowed externally which will have to be paid back versus money provided by the owners. Ideally, this ratio should be less than 2.0.Normally, the lower this ratio, the more favorable it is for the company.Too much debt puts a business at risk because it may have trouble meeting its obligations to its lenders.
33 Current Ratio and Debt to Equity Ratio Current assets are $1,200,000 and total current liabilities are $600,000.Calculate current ratio.Calculation:Current Ratio = 1,200,000 / 600,000= 2or1200,000 : 600,0002 : 1Debt to Equity RatioRequired: Calculate debt to equity ratio.External Equities / Internal Equities= 1,200,000 / 1,800,000= 0.66 or 4 : 6Equity share capital Capital reserve Profit and loss account 6% debentures Sundry creditors Bills payable Provision for taxation Outstanding creditors1,100, , , , , , , ,000
34 Financial Performance Ratios continued Return on equity ratioEquals net profit/owner’s equityIndicates the rate of return the owners/stockholders are receiving on their investments. There is not an ideal ratio; however, it is used to compare with other types of investments to see if there may be another investment that is more desirable.Normally, the higher the ratio, the more favorable it is for the company.
35 Financial Performance Ratios continued Net income ratioEquals total sales/net incomeShows the amount of sales needed for each dollar of net income. While there is not an ideal ratio, managers use this number to compare to past periods to determine how changes in sales affect net income.Normally, the lower the ratio, the more favorable it is for the company, as it takes less in sales to generate net income.
36 Return on Equity Ratio and Net Income Ratio Return on equity or ROE can be calculated as,Calculate return on equity share capital from the following information:Equity share capital ($1): $1,000,000; 9% Preference share capital: $500,000; Taxation rate: 50% of net profit; Net profit before tax: $400,000.Calculation:Return on Equity Capital (ROEC) ratio = [(400,000 − 200,000 − 45,000) / 1,000,000 )× 100]= 15.5%Net Income RatioFormula:Net Profit Ratio = (Net profit / Net sales) × 100Example:Total sales = $520,000; Sales returns = $ 20,000; Net profit $40,000Calculate net profit ratio.Net sales = (520,000 – 20,000) = 500,000Net Profit Ratio = [(40,000 / 500,000) × 100]= 8%
37 Ratios Financial Performance Ratio Formula Current Ratio Current Assets/Current LiabilitiesDebt to Equity RatioTotal Liabilities/Owners’ EquityReturn on Equity RatioNet Profit/Owners’ EquityNet Income RatioTotal Sales/Net Income
38 GROSS vs. NET Gross means amount before any expenses are deducted Net means amount after expenses are deducted
39 DiscrepanciesDiscrepancies are differences between actual and budgeted performance.Also know as a variance