SMALL BUSINESS MANAGEMENT Chapter 10 Financial Management Managing Your Business Finances If you want to succeed in business, you need to know about financial management. No matter how skilled you are at creating a product, providing a service, or marketing your wares, the money you earn will slip between your fingers if you don't know how to efficiently collect it, keep track of it, save it, and spend or invest it wisely. Poor financial management is one of the leading reasons that businesses fail. In many cases, failure could have been avoided if the owners had applied sound financial principles to all their dealings and decisions. Financial management is not something that you can leave to your banker, financial planner, or accountant — you need to understand the basic principles yourself and use them on a daily basis, even if you plan to leave the more complicated work to hired professionals What issues concerning financial management did ocean hotel encounter? Accounting cycle Profitability Productivity financing Short term financial planning Long term financial planning What issues concerning financial management did ocean hotel encounter? Ocean Hotel Ocean Hotel

To evaluate performance Entrepreneurs To plan and control To motivate employees Investors To evaluate performance Accounting Information Lenders To evaluate creditworthiness Uses of Accounting information Unless your business is accounting or bookkeeping, keeping financial records is probably not what you do best. Most likely, you'd rather spend your time selling your product or service. However, if you are going to run a successful business, accurate and timely financial information is a must. Here are some of the reasons why you need a good financial recordkeeping system: Monitoring the success or failure of your business. Providing the information you need to make decisions. Obtaining bank financing.. Obtaining other sources of capital. Budgeting. Preparing your income tax return. Submitting sales taxes. Distributing profits. Government To verify taxes owed To approve new stock issues

The Accounting Cycle Recording Transactions Classifying Transaction Totals Summarizing Data Your Basic Bookkeeping To succeed in business, one of your most important tools is financial analysis, based on your business records. Accurate financial records will help you answer some very important questions. Are you making money, or losing it? How much? Is your business on sound financial ground, or are troubles lurking ahead? A sound bookkeeping system is the foundation on which all of this valuable financial information can be built.As a small business owner, you probably rely on an outside accountant to do your taxes and prepare financial statements. However, like many small business owners, you may find that it's too expensive to pay an accountant to do routine bookkeeping chores. Someone in your organization must take on the responsibility of keeping an accurate set of financial records. Fortunately, you may find this task easier than you thought, especially if you use your computer. Balance Sheet (Statement of Financial Position) Income Statement (Statement of Profit and Loss) Cash Flow Statement and/or Changes in Financial Position

Financial Statements Balance Sheet (Statement of Financial Position) Snapshot of what a business owns and what it owes Income Statement (Statement of Profit and Loss) Results of operations over a given period of time Cash Flow Statement (Ch 7) Changes in Financial Position Changes in balance sheet accounts of a set period of time

Accounting Systems for Small Business Small Business Computer Systems Top 5 Accounting Software For Small Business Simply Accounting Accounting Software MYOB Plus Accounting Software Intuit QuickBooks Accounting Software Peachtree Complete Accounting Software AccountEdge Accounting Software

Accounting Systems for Small Business Disadvantages Cost Obsolescence Employee Resistance Capabilities Setup Time Failure to Compensate for Poor Bookkeeping

Short term Financial Planning Short-term corporate finance decisions are called working capital management deal with the balance of current assets and current liabilities; the focus here is on managing cash, inventories, short-term borrowing and lending (e.g., the credit terms extended to customers).

Preparing an estimated future financial result Management of Financial Information for Planning Short Term Financial Planning Preparing an estimated future financial result ( Pro forma income statement or budget ) Budget is valuable because Clarification of Objectives Coordination Evaluation and Control Variance analysis

Long term Financial Planning Capital investment decisions comprise the long-term choices about which projects receive investment, whether to finance that investment with equity or debt, when or whether to pay dividends to shareholders.

The Capital Investment Decision The Capacity Decision Management of Financial Information for Planning Long Term Financial Planning The Capital Investment Decision Baron of Beer The Capacity Decision Cottage Cheesecake The expansion Decision Suger high Sugar high Sugar high

Clodhoppers What are some of the problems of growth of Kraves Candy Company? What could Chris emery and Larry Finson do to solve these problems? What are the advantages and disadvantages of diversifying to other products besides clodhoppers? What are some of the problems of growth of Kraves Candy Company? owner-manager fatigue and stress, lack of communication, lack of coordination, shortage of cash, low profitability, breakdown in production efficiency, lack of information and possible decreasing employee morale. What could Chris emery and Larry Finson do to solve these problems? What are the advantages and disadvantages of diversifying to other products besides clodhoppers?

The Capital Investment Decision rate of return method (PG 315 ) payback method (PG 315 ) present value method NPV or IRR ( Get a financial calculator ) Using ARR can give you a quick estimate of the project's net profits, and can provide a basis for comparing several different projects. Under this method of analysis, returns for the project's entire useful life are considered (unlike the payback period method, which considers only the period it takes to recoup the original investment). However, the ARR method uses income data rather than cash flow and it completely ignores the time value of money. There are a couple of drawbacks to using the payback period method. For one thing, it ignores any benefits that occur after the payback period, so a project that returns $1 million after a six-year payback period is ranked lower than a project that returns zero after a five-year payback. But probably the major criticism is that a straight payback method ignores the time value of money.

Factors affecting the investment in this business are: 1. Prime rate of interest - usually an investor will want a return at least two to three times the prime rate. 2. There is also some tax, personality and personal considerations. Refer to chapter five for all the considerations on buying a business Question 3. Calculate the rate of return for the following investment. The total cost of the investment is $250,000, the depreciable life of the investment is 10 years and the annual profit (net of depreciation) is $30,000. What considerations other than financial ones exist? Answer: Rate of Return = Average profit / average investment = $30,000/125,000 = 24%

Assume the annual depreciation charge for the investment in problem 3 is $25,000. Determine the payback period of the investment. Payback period = Total Investment / (Annual Depreciation + Annual Profit). = $250,000 /($25,000 + $30,000) = 4.55 years

The Capacity Decision break even point which tells you the sales volume you need to break even, under different price or cost scenarios

Determine the break-even point in dollars for an investment with fixed costs of $100,000 and an estimated contribution of 60 percent. How much revenue would it need to produce before your would invest? Answer: B.E.P. = Fixed Costs /Contribution per unit = $100,000 /.6 = $166,667

Effect of fixed cost adjustments Effect of variable cost adjustments Management of Financial Information for Planning The Expansion Decision Effect of fixed cost adjustments Effect of variable cost adjustments Use BEP on incremental basis

Making profit but cash poor Evaluation of Financial Performance Management of Current Financial Position Making profit but cash poor length of time for payments three essential components time taken to pay accounts payable time taken to sell inventory time taken to receive payment for inventory

Mohair Sock Explain how this firm could have a strong net income as reflected on the income statement but be cash poor so as not to meet their short term obligations? Mohair Socks Mohair Socks

Evaluation of Financial Performance Evaluation of Financial Statements Ratio Analysis Liquidity ratios current ratio = current assets / current liabilities over 1:1, usually between 1:1 and 2:1 Acid test/ Quick ratio = current assets-inventories/ current liabilities 1:1 is considered healthy Liquidity Ratios < Liquidity ratios are probably the most commonly used of all the business ratios. Your creditors may often be particularly interested in these because they show the ability of your business to quickly generate the cash needed to pay your bills. This information should also be highly interesting to you, since the inability to meet your short-term debts would be a problem that deserves your immediate attention.Liquidity ratios are sometimes called working capital ratios because that, in essence, is what they measure.The liquidity ratios are: the current ratio the quick ratio Liquidity ratios are commonly examined by banks when they are evaluating a loan application. Once you get the loan, your lender may also require that you continue to maintain a certain minimum ratio, as part of the loan agreement. For that reason, steps to improve your liquidity ratios are sometimes necessary.

Evaluation of Financial Statements Ratio Analysis Productivity ratios Inventory turnover = COGS / Average inventory at average cost Inventory turnover = Sales / Average inventory at retail price Collection period = Accounts receivable / Daily credit sales

Evaluation of Financial Statements Ratio Analysis Profitability ratios Gross margin = sales - COGS Profit on sales = net profit before tax / sales Expense ratio = Expense item / Sales Return on Investment = Net profit before tax / owner’s equity

Evaluation of Financial Statements Ratio Analysis Debt ratio Total debt to equity = Total debt / owner’s equity not greater than 4:1

Advantages of Credit Use will undoubtedly increase sales necessary to remain competitive credit customers exhibit more store loyalty credit customers are more concerned with quality of service vs. price credit records can be used for future planning

Disadvantages of Credit Use will be some bad debts - depends on credit policy and monitoring slow payers cause lost interest and capital increases bookkeeping, mailing and collection expenses

Management of a Credit Program Determine Administrative Policies Set Criteria for Granting Credit Set up a System to Monitor Accounts Establish a Procedure for Collection

Credit and the Small Business Use of Bank Credit Cards Maybe cheaper and easier than running your own credit program Usually 2%-6% of transaction

Sam’s Paint and Drywall Pg 324 6a. From the above balance sheet and income statement of Sam's Paint and Drywall determine the following ratios: 1. Current 2. Inventory turnover 3. Profit to sales 4. Return on investment 5. Total debt to equity 6b. From Dunn & Bradstreet's Key Business Ratios on industry norms, evaluate each of the above ratios.

Appliance Recyclers Discuss the financial problems created by growth? What strategy was followed to improve cash flow What finally helped Anthony to be successful? Appliance recyclers

Appendices A. Checklist for buying a small business computer B. Use of Financial Ratios for a Small Business (Car Dealer)

Cash Flow Experience Dick's Draperies has gross sales of $15,000 per month, one half which are on credit (paid within 30 days). Monthly expenses are as follows: wages, $3,000; utilities and rent, $2,000; advertising, $300; miscellaneous, $500. Inventory is purchased every three months and totals $30,000 for each order. Yearly expenses paid for in advance are insurance of $1,000 and a rent deposit of $700. Prepare a six-month cash flow statement for Dick's Draperies. What advice would you give this business based on the cash flow statement?

Every accounting entry is based on a business transaction, which is usually evidenced by a business document, such as a check or a sales invoice. A journal is a place to record the transactions of a business. The typical journals used to record the chronological, day-to-day transactions are sales and cash receipts journals and a cash disbursements journal. A general journal is used to record special entries at the end of an accounting period. While a journal records transactions as they happen, a ledger groups transactions according to their type, based on the accounts they affect. The general ledger is a collection of all balance sheet, income, and expense accounts used to keep a business's accounting records. At the end of an accounting period, all journal entries are summarized and transferred to the general ledger accounts. This procedure is called "posting." A trial balance is prepared at the end of an accounting period by adding up all the account balances in your general ledger. The sum of the debit balances should equal the sum of the credit balances. If total debits don't equal total credits, you must track down the errors. Finally, financial statements are prepared from the information in your trial balance.

Accounting Systems for Small Business One-Book System One-Write System Multi-journal System Outsourcing Financial Activities One-Book System For very small businesses with very few transactions fig 10-8 in text gives example One-Write System Similar to one book but uses a carbon to reduce transcription errors Multi-journal System Used more and more because of inexpensive computers and software systems Outsourcing Financial Activities Usually keep journal transaction recording and ledger preparation in house and farm out the production of financial statements