Essential Standard 4.00 Understanding the role of finance in business. 1

Objective 4.01 Understand financial management. 2

Topics Financial planning Business budgets Financial records and statements Financial performance ratios 3

Financial planning 4

Financial Planning Why should a business do financial planning? –Reduces financial uncertainties –Increases control of financial activities –Provides a ‘map of finances’ for business –Makes it easier to ‘stick’ to financial processes and goals. What are the phases of business financial planning? –Start-up Financial 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. –Operation Financial planning includes determining whether they are making enough money to operate. The basic formula used is Revenue – Expenses = Profit or Loss. –Expansion Financial planning includes determining whether enough money is made to cover growth opportunities. 5

Financial Planning continued What is the basic financial equation? Revenue – Expenses = Profit or Loss In order to have a profit, which will be greater? –Profit = Revenue > Expenses In order to have a loss, which will be greater? – Loss = Revenue < Expenses 6

Business budgets 7

Business Budgets Types of business budgets: –Start-up budget –Operating budget –Cash budget 8

Business Budgets continued Steps for preparing a business budget: 1.Prepare a list of income and expense items. 2.Gather accurate information from business records. 3.Create the budget. 4.Clearly communicate the budget to key employees in order to make sound business decisions. 9

Financial records and statements 10

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. Financial records used by businesses: –Asset records –Depreciation records –Inventory records –Records of accounts –Cash records –Payroll records –Tax records 11

Financial Records and Statements continued What are assets? Assets are what a company owns. What are liabilities? Liabilities are what a company owes. What is owner’s equity? Owner’s equity is the value of the owner’s investment in the business. Owner’s Equity = Assets – Liabilities. Another name for owner’s equity is stockholder’s equity. 12

Financial Records and Statements continued What 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. 13

Financial performance ratios 14

Financial Performance Ratios What are 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 ratio –Debt to equity ratio –Return on equity ratio –Net income ratio 15

Financial Performance Ratios continued Current ratio –How is current ratio calculated? –Equals current assets/current liabilities –What does this ratio represent? –Represents 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. –Which is more favorable, higher or lower? –Normally, the higher the ratio, the more favorable it is for the company. 16

Financial Performance Ratios continued Debt to equity ratio –How is debt to equity ratio calculated? –Equals total liabilities/owner’s equity –What does the ratio represent? –Shows how much the business relies on money borrowed externally versus money from within the business. Ideally, this ratio should be less than 2.0. –Which is more favorable, higher or lower? –Normally, the lower this ratio, the more favorable it is for the company. 17

Financial Performance Ratios continued Return on equity ratio –How is current ratio calculated? –Equals net income/owner’s equity (Net income can also be called net profit according to the text.) –What does this ratio represent? –Indicates 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. –Which is more favorable, higher or lower? –Normally, the higher the ratio, the more favorable it is for the company. 18

Net income ratio –How is current ratio calculated? –Equals total sales/net income (Hint: This is only total SALES, not total income.) –What does this ratio represent? –Shows 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. –Which is more favorable, higher or lower? –Normally, the lower the ratio, the more favorable it is for the company, as it takes less in sales to generate net income. 19