Objective 4.01 Understanding Financial Management. 1

Topics Financial planning Business budgets Financial records and statements Financial performance ratios 2

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. 3

Financial Planning Phases of business –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. 4

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. 5

Business Budgets 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. 6

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 7

Financial Records and Statements What are assets? –Anything of value that a company owns –Cash, investments, inventory, property, equipment, intellectual property What are liabilities? –Anything that a company owes –Salaries, loans, bills, long-term debt What is owner’s equity? –Any debt owed to the business owners

Financial Records and Statements 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. 9

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 10

Financial Performance Ratios Current Ratio –Equals current assets/current liabilities –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. –The higher the ratio, the more favorable it is for the company. 11

Financial Performance Ratios Debt to Equity Ratio –Equals total liabilities/owner’s equity –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. –The lower this ratio, the more favorable it is for the company. 12

Financial Performance Ratios Return on Equity Ratio –Equals net profit/owner’s equity –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. –The higher the ratio, the more favorable it is for the company. 13

Financial Performance Ratios Net Income Ratio –Equals total sales/net 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. –The lower the ratio, the more favorable it is for the company, as it takes less in sales to generate net income. 14