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 for Business Beginning of a Business (Start-up) –Money needed to start –Financing sources –Money to operate until profitable –Sources of sales –Expenses

Financial Planning for Business Ongoing –Paying employees –Supplies & materials –Maintaining the building and equipment –Technology updates

Financial Planning for Business Business Expansion –Reasons to expand – serve more customers, reach unserved markets, or sell new products –Costs associated with expansion – research, new employees, marketing activities –Need to determine if revenue will be greater than costs

What is a Budget? Budget – detailed plans for the financial needs of individuals, families, and businesses. Purposes of a Budget –Anticipate sources and amounts of income –Predict types and amounts of expenses A budget is successful when revenue > expenses

Types of Budgets Start-Up – plans income and expenses from the beginning of the new business or a major expansion until it becomes profitable. –Includes buildings, equipment, inventory, supplies, materials, employees, utilities, licenses, advertising and transportation

Types of Budgets Operating Budget – a financial plan for ongoing operations of the business for a specific period of time –Usually 3 months, 6 months or 1 year

Types of Budgets Cash Budget – estimate of actual money received and paid out for a specific period. –Need to determine if there will be enough money to pay bills or if the business will need to borrow money

4 Steps in Planning a Budget 1. Prepare a list of each type of income and expense 2. Gather accurate info for each type of income and expense from business records 3. Create a budget and calculate income, expenses, and net profit or loss 4. Explain the budget to those who make decisions

What is income?  Money received for goods or services Net Sales Revenue Receipts Earnings Interest The business has net income when revenue is greater than expenses. 12

What is expense?  Cost or charge incurred; a payment of money SalariesAdvertising UtilitiesTelephone RentRepairs/Maintenance InsuranceTaxes The business has net loss when expenses are greater than revenue. 13

GROSS vs. NET Gross means amount before any expenses are deducted Net means amount after expenses are deducted 14

Discrepancies Discrepancies are differences between actual and budgeted performance. Also know as a variance 15

Sample Company Budget January 1, xxxx to December 31, xxxx CategoryActualBudgetDifference Inflows Net Sales385,400300,00085,400 Cost of Goods Merchandise Inventory, January 1160,000 0 Purchases120,00090,00030,000 Freight Charges 2,500 2, Total Merchandise Handled282,500252,00030,500 Less Inventory, December 31100,000120,000(20,000) Cost of Goods Sold182,500132,00050,500 Gross Profit202,900168,00034,900 Interest Income (200) Total Income202,500168,70033,800 Expenses Salaries68,25045,00023,250 Utilities5,8004,5001,300 Rent23,000 0 Office Supplies2,2503,000(750) Insurance3,900 0 Advertising8,6509,000(350) Telephone2,7002, Travel and Entertainment2,5502, Dues & Subscriptions1,1001, Interest Paid2,1402,500(360) Repairs & Maintenance1,2501, Taxes & Licenses11,70010,0001,700 Total Expenses133,290106,85026,440 Net Income$69,210$61,850$7,360 16

17 Startup Budget March 17, 2011 Cash Needed% of Actual Cash% of to StartTotal SpentTotalVarianceTotal Monthly Costs Salary of owner-manager$6, %$6, %($500)15.8% All other salaries and wages7, %7, %(100)3.2% Rent1,0002.3%9001.9% % Advertising2,0004.6%2,0004.3%0 Delivery expense %1,0002.1%(600)19.0% Supplies5001.1%1,5003.2%(1,000)31.6% Telephone5001.1%5001.1%0 Other utilities5001.1%7601.6%(260)8.2% Insurance6001.4%6001.3%0 Taxes, including social security1,0002.3%1,0002.1%0 Interest5001.1%5001.1%0 Maintenance3000.7% %0 Legal and other professional fees3,0006.9% 3,3007.0%(300)9.5% Miscellaneous5001.1% %0 Subtotal$23, % $26, %($2,660)84.2% One-Time Costs Fixtures and Equipment$10, % $11, %($1,000)31.6% Decorating and remodeling1,0002.3% 1,2002.6%(200)6.3% Installation charges5001.1% %(100)3.2% Starting inventory5, % 4,0008.5%1, % Deposits with public utilities1,0002.3% 1,2002.6%(200)6.3% Legal and other professional fees5001.1% %0 Licenses and permits5001.1% %0 Advertising and promotion for opening5001.1% %0 Cash7501.7% %0 Other2000.5% %0 Subtotal$19, % $20, %($500)15.8% Totals$43,750100% $46,910100%($3,160)100%

18 SAMPLE Operating Budget July 1, 2004 to June 30, 2005 Income Membership dues - $25.00 $ Fund-raiser $ Contest entry award $25.00 Aluminum can sales $27.00 T-shirt sales$ Parties $ Total Income$1, Expenses Parties $ Intramurals $15.00 Gifts $55.00 Refreshments $ National/regional dues $ Fund-raiser $44.00 T-shirts $ Picnic $99.00 Office supplies/duplicating $28.00 State & County sales tax $19.00 Total Expenses $1, AVAILABLE FUNDS -0-

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 19

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 assets –Depreciation records – identify the amount assets have decreased in value due to their age and use –Inventory 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 20

Financial Records and Statements –Records of accounts – identify all purchases and sales made using credit Accounts 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 account –Cash records – list all cash received and spent by the business 21

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. 22

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

Financial Records and Statements What is owner’s equity? –Any debt owed to the business owners –Owner’s equity is the value of the owners’ investment in the business –Value of business after liabilities are subtracted from assets

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. 25

26 Balance Sheet

27 Income Statement

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 28

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. 29

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. 30

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. 31

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. 32

Financial Performance Ratios Financial Performance Ratio Formula Current RatioCurrent Assets/Current Liabilities Debt to Equity RatioTotal Liabilities/Owners’ Equity Return on Equity RatioNet Profit/Owners’ Equity Net Income RatioTotal Sales/Net Income 33