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

Understand financial management. Objective 4.01 Understand financial management.

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

Financial planning

Financial Planning Why should a business do financial planning? What are the phases of business financial planning? Start-up Operation Expansion What happens during each phase? 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? What happens during each phase? 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.

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

Business budgets

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

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.

Financial records and statements

Financial Records and Statements What is the purpose of financial records? Financial records used by businesses: Asset records Depreciation records Inventory records Records of accounts Cash records Payroll records Tax records 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 and Statements continued What are assets? What are liabilities? What is owner’s equity? What are financial statements? What is the difference between a balance sheet and an income statement? 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. 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.

Financial performance ratios

Financial Performance Ratios What are financial performance ratios? The four main types of financial ratios: Current ratio Debt to equity ratio Return on equity ratio Net income ratio What are financial performance ratios? Financial performance ratios are comparisons using a company’s financial data to determine how well a business is performing.

Financial Performance Ratios continued Current ratio How is current ratio calculated? What does this ratio represent? Which is more favorable, higher or lower? Debt to equity ratio How is debit to equity ratio calculated? What does the ratio represent? 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. 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. Normally, the lower this ratio, the more favorable it is for the company.

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