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

Objective 4.01 Understand financial management. 2

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

Financial planning 4

 Read Focus on Real Life on pages 292 in Intro to Business, 6e, Thomson South-Western textbook.  Discuss the following questions: 1.What kind of financial information is used by businesses? 2.What should businesses do with financial information? 3.What is financial planning? Financial planning 5

 Why should a business do financial planning? 1.Reduces financial uncertainties 2.Increases control of financial activities 3.Provides a ‘map of finances’ for business 4.Makes it easier to ‘stick’ to financial processes and goals. 6 Financial Planning

 What are the phases of business financial planning and what happens during each phase? 1.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. 2.Operation  Financial planning includes determining whether they are making enough money to operate. The basic formula used is Revenue – Expenses = Profit or Loss. 3.Expansion  Financial planning includes determining whether enough money is made to cover growth opportunities. 7 Financial Planning

 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 8 Financial Planning continued

RevenueExpensesDifferenceProfit/Loss $85,695$72,624 $1,824,300$2,183,680 $729,655$499,220 9 Profit or Loss

 Complete the Profit or Loss Activity.  Answer Goal Questions on Page 292. Financial Planning To Do: 10

Business budgets 11

Types of business budgets:  Start-up budget used by a new business or during expansion of a business. Start-up budget plans income and expenses from the beginning until profits are made.  Operating budget used for ongoing business operations for a specific period (usually for 3 months, 6 months, or 1 year). Prior income/expense budgets are reviewed to predict and prepare the budget for the next period.  Cash budget used to estimate cash flow in and out (actual money received in and paid out) of a business for a specific period. A cash budget will determine if a business has adequate financial resources on hand to pay bills as they become due or it they will need to borrow money. It will also show them how much money is on hand to invest. 12 Business Budgets

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. 13 Business Budgets continued

 Enter Grocery Store, Inc. Operating Budget Sample in a spreadsheet. Increase the income and expenses by 7%. Decrease the income and expenses by 1.5%. Write a paragraph discussing how the increase could impact future budgets.  Answer Key Concepts (1-3) on Page Business Budgets To Do:

 Locate a newspaper, magazine, or internet article that describes a change in income or expenses for a business for a specific period(s). Write 2 paragraphs discussing how managers should use the information when developing an operating budget for the next period. 15 Business Budgets Homework:

Financial records and statements 16

 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: 1.Asset records 2.Depreciation records 3.Inventory records 4.Records of accounts 5.Cash records 6.Payroll records 7.Tax records

 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. 18 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. 19 Financial Records and Statements continued

Financial performance ratios 20

 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 21 Financial Performance Ratios

 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. 22 Financial Performance Ratios continued

 Debt to equity ratio  How is debit 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. 23 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. 24 Financial Performance Ratios continued

 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. 25 Financial Performance Ratios continued