CHAPTER 12 FINANCIAL MANAGEMENT

12-1 Financial Planning FINANCIAL PLANNING Ongoing Operations Revenue – all income that a business receives over a period of time Expenses - the costs of operating a business

12-1 Financial Planning FINANCIAL PLANNING Ongoing Operations BASIC FINANCIAL EQUATION Revenue – Expenses = Profit or Loss Revenue > Expenses = Profit Revenue < Expenses = Loss

12-1 Financial Planning FINANCIAL PLANNING Business Expansion Businesses expand to be able to serve more customers, reach unserved markets, and sell new products. Costs Associated With Business Expansion New factories/equipmentMarketing activities planned New employees/trainingMarketing activities implemented Research new productsDistribute products Locate new marketsPromote products

12-1 Financial Planning DEVELOPING BUSINESS BUDGETS A budget provides detailed plans for the financial needs of individuals, families, and businesses. A business budget has two main purposes: 1.Anticipate sources and amounts of income for a business. 2.Predict the types and amounts of expenses for a specific business activity or the entire business.

12-1 Financial Planning DEVELOPING BUSINESS BUDGETS Sources of Budget Information The main source of budget information comes from the financial records of a business The SBA provides guides and tools to help owner’s predict income and expenses Private businesses collect and publish financial information on similar businesses and industries Banks will help new businesses plan a budget

12-1 Financial Planning DEVELOPING BUSINESS BUDGETS Budget Preparation Goals 1.Determine the sources and amounts of income 2.Identify the types of expenses 3.Predict their costs 4.Determine how income will be distributed to cover expenses 5.Reward investors (if there is a profit)

12-1 Financial Planning DEVELOPING BUSINESS BUDGETS Budget Preparation The Budget Process Prepare a list of each type of income and expense that will be a part of the budget Gather accurate information from business records and other information sources for each type of income and expense

12-1 Financial Planning DEVELOPING BUSINESS BUDGETS Budget Preparation The Budget Process Create the budget by calculating each type of income, expense, and the amount of net income or loss. Explain the budget to people who need financial information to make decisions

12-1 Financial Planning TYPES OF BUDGETS START-UP BUDGET – plans income and expenses from the beginning of a new business or major business expansion until it becomes profitable. OPERATIING BUDGET – describes the financial plan for ongoing operations of the business for a specific period. (usually planned for 3, 6, or 12 months) CASH BUDGET – an estimate of the actual money received and paid out for a specific period.

12-2 Financial Records & Financial Statements FINANCIAL RECORDS Used to record and analyze the financial performance of a business. They provide detailed information about the financial activities of the company. Local, state, and federal governments require some records.

12-2 Financial Records & Financial Statements FINANCIAL RECORDS Types of Records Asset Records – identify the buildings and equipment owned by the business, their original and current value, and the amount owed if money was 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 quantity of resources and products on hand along worth the current value of each.

12-2 Financial Records & Financial Statements FINANCIAL RECORDS Types of Records Record of Accounts – identify all purchases and sales made using credit. – Accounts payable: identifies the companies from which credit purchases were made and the amounts purchased, paid and owed. – Accounts receivable: identifies customers that made purchases using credit and the status of each account. Cash records – list all cash received and spent by the business.

12-2 Financial Records & Financial Statements FINANCIAL RECORDS Types of Records Payroll records – contain information on all employees of the company, their compensation, and benefits. Tax records – show all taxes collected, owed, and paid.

12-2 Financial Records & Financial Statements FINANCIAL STATEMENTS ASSETS – what a company owns LIABILITIES – what a company owes OWNER’S EQUITY – the value of the owner’s investment in the business

12-2 Financial Records & Financial Statements FINANCIAL STATEMENTS Financial Statements – reports that sum up the financial performance of a business Balance sheet – a company reports its assets, liabilities, and owner’s equity Income statement – sales, expenses, profits (losses) for a specific time period are reported

12-2 Financial Records & Financial Statements FINANCIAL STATEMENTS The Balance Sheet

12-2 Financial Records & Financial Statements FINANCIAL STATEMENTS The Balance Sheet

12-2 Financial Records & Financial Statements FINANCIAL STATEMENTS The Income Statement

12-2 Financial Records & Financial Statements FINANCIAL STATEMENTS The Income Statement

12-2 Financial Records & Financial Statements FINANCIAL STATEMENTS The Income Statement Revenue – all income received by the business during the period. Expenses – all the costs of operating the business during the period. Net Income – when revenue is greater than expenses. Net loss – when expenses are greater than income.

12-3 Payroll Management Payroll Systems Payroll – the financial record of employee compensation, deductions, and net pay. Payroll System – maintains information on each employee to be able to calculate the company’s payroll and to make the necessary payments to each employee.

12-3 Payroll Management Payroll Systems How are employees paid? Weekly, bi-weekly, monthly Hourly, salary, commissions, bonuses, profit sharing Benefits: insurance, vacation, sick leave PTO, retirement plans, education assistance

12-3 Payroll Management Payroll Systems Payroll Taxes Income Taxes – federal government, most states, some local governments require employers to withhold income tax from their employees’ pay.

12-3 Payroll Management Payroll Systems Payroll Taxes Social Security and Medicare – FICA (Federal Insurance Contributions Act) – The government requires employers to withhold and deposit these contributions from employee’s paychecks along with matching contributions by the employer.

12-3 Payroll Management Payroll Systems Payroll Taxes Unemployment Taxes – Employers pay Federal Unemployment Tax (FUTA) – The FUTA rate is 6.0% and employers can take a credit of up to 5.4% of taxable income if they pay state unemployment taxes. This amount is deducted from the amount of employee federal unemployment taxes you owe.

12-3 Payroll Management Preparing A Payroll Payroll records – documentation used to process earnings payments and record each employee’s pay history.

12-3 Payroll Management Preparing A Payroll Preparing Paychecks Earning Report – provides information for the current pay period as well as the cumulative amounts for the year. Direct Deposit – the employer does not receive a printed paycheck but is given a receipt of the funds transfer.

12-4 Financial Decision Making USING FINANCIAL INFORMATION Important Financial Information Balance Sheet Reporting assets, liabilities and Owner’s Equity Income Statement Reporting Sales, expenses and profits (loss)

12-4 Financial Decision Making USING FINANCIAL INFORMATION Understanding Financial Performance Ratios Financial performance ratios: comparison of a company's financial elements that indicate how well the business is performing.

12-4 Financial Decision Making USING FINANCIAL INFORMATION Understanding Financial Performance Ratios CURRENT RATIO = Current Assets Current Liabilities DEBT TO EQUITY RATIO = Total Liabilities Owner’s Equity RETURN ON EQUITY RATIO = Net Profit Owner’s Equity NET INCOME RATIO = Total Sales Net Income

12-4 Financial Decision Making USING FINANCIAL INFORMATION Understanding Financial Performance Ratios Current Ratio: Current assets compared to the current liabilities. Current assets are those that the business could convert to cash within one year. Current liabilities are all payments owed to creditors that must be made within one year. A healthy business will have a 1:1 ratio.

12-4 Financial Decision Making USING FINANCIAL INFORMATION Understanding Financial Performance Ratios Debt to Equity Ratio: the company’s liabilities divided by the owner’s equity Tell you how much the business is relying on the money borrowed from others that will have to be paid back rather than money provided by the owner. Banks want to see a debt to equity ratio of 1:1, but no greater than 2:1

12-4 Financial Decision Making USING FINANCIAL INFORMATION Understanding Financial Performance Ratios Return Equity Ratio: the net profit of a business compared to the amount of owner’s equity The return on equity ratio shows the rate of return the owners are getting on the money they invested in the company.

12-4 Financial Decision Making USING FINANCIAL INFORMATION Understanding Financial Performance Ratios Net Income Ratio: the total sales compared to the net income for a period of time (6-12 months) The net income ratio shows how much profit is being made by each dollar of sales for the period being analyzed.

12-4 Financial Decision Making MAKING FINANCIAL DECISIONS Managers are responsible for the financial health of their company and for the specific areas of the company under their control. They regularly check to see if income and expenses are meeting budgeted amounts. Income should be as high or higher than planned. Expenses should not exceed the budgeted amount.

12-4 Financial Decision Making MAKING FINANCIAL DECISIONS Managers get regular financial reports and examine them carefully, looking for discrepancies (differences between actual and budgeted performance)

12-4 Financial Decision Making MAKING FINANCIAL DECISIONS Lastly, managers need to make adjustments. If income and expenses are similar to the budget, he will not need to take action. If there are financial problems, managers will take corrective action to try to bring performance back in line with the budget.