1. Creating a Successful Financial Plan Volume is vanity; profitability is sanity …Brad Skelton It is better to solve problems than crises …John Guinther

2. Financial Management A process that provides entrepreneurs with relevant financial information in an easy-to-read format on a timely basis; it allows entrepreneurs to know not only how their businesses are doing financially, but also why they are performing that way.

3. Basic Financial Statements The Balance Sheet a financial statement that provides a snapshot of a business’s financial position, estimate its worth on a given date; it is built on the fundamental accounting equation: a financial statement that provides a snapshot of a business’s financial position, estimate its worth on a given date; it is built on the fundamental accounting equation: Assets = Assets = Liabilities + Owner’s Equity

4. Basic Financial Statements (cont’d) current assets- assets such as cash and other items to be converted into cash within one year or within the company’s normal operating cycle. current assets- assets such as cash and other items to be converted into cash within one year or within the company’s normal operating cycle. fixed assets- assets acquired for long-term use in a business. fixed assets- assets acquired for long-term use in a business. liabilities- creditors’ claims against a company’s assets. liabilities- creditors’ claims against a company’s assets. current liabilities- those debts that must be paid within one year or within the normal operating cycle of a company. current liabilities- those debts that must be paid within one year or within the normal operating cycle of a company. long-term liabilities- liabilities that come due after one year. long-term liabilities- liabilities that come due after one year. owners equity- the value of the owner’s investment in the business. owners equity- the value of the owner’s investment in the business.

5. Basic Financial Statements (cont’d) The Income Statement a financial statement that represents a “moving picture” of a business, comparing its expenses against its revenue over a period of time to show its net profit (or loss). a financial statement that represents a “moving picture” of a business, comparing its expenses against its revenue over a period of time to show its net profit (or loss). cost of goods sold- the total cost, including shipping of the merchandise sold during the accounting period. cost of goods sold- the total cost, including shipping of the merchandise sold during the accounting period. gross profit margin- gross profit divided bye net sales revenue. gross profit margin- gross profit divided bye net sales revenue. operating expenses- those costs that contribute directly to the manufacture and distribution of goods. operating expenses- those costs that contribute directly to the manufacture and distribution of goods.

6. Basic Financial Statements (cont’d) The Statement of Cash Flows a financial statement showing the changes in a company’s working capital from the beginning of the year by listing both the sources and the uses of those funds. a financial statement showing the changes in a company’s working capital from the beginning of the year by listing both the sources and the uses of those funds.

7. Creating Projected Financial Statements Entrepreneurs must maintain a reserve of capital to cover the expenses that exceeds the income. Pro Forma Statements for the Small Business Pro Forma Income Statement ( Pro Forma Income Statement (Financial statement that shows the projected results of the operations of a firm over a specific period) Pro Forma Balance Sheet ( Pro Forma Balance Sheet (Financial statement that shows a projected snapshot of a company’s assets, liabilities, and owner’s equity at a specific point in time) Pro Forma Statement of Cash Flows ( Pro Forma Statement of Cash Flows (Financial statement that shows the projected flow of cash into and out of a company for a specific period)

8. Creating Projected Financial Statements (cont’d) Pro Forma Income Statement 2 options: - To set a profit target and work up. OR - To develop a sales forecast and work down. In any small business, the annual profit must be large enough to produce a return for the time the owner spend operating the business, plus a return on their investment in the business.

9. Method 1: Targeting profit to determine sales level to achieve the targeted profit. Step 1. Net Profit margin= Net Profit/ Annual Net Sales Targeted income of a bookstore owner is $ 29000 and typical bookstore’s net profit margin is 9.3% (from annual statement studies). So, Net sales (annual)= 29000/.093=$ 311828. Step 2. Typical COGS of bookstore comprises 61.4%, i.e., $191462. Step 3. Compute projected Income Statement: Net sales (100%) $311828 -COGS (61.4%) 191462 Gross Profit margin (38.6%) 120366 -Operating expenses (29.3%) 91366 Net Profit (before tax) (9.3%) $29000 Step 4. Break down into daily sales figure. Average daily sales= Net sales/ # of days in a year = $ 311828/300 days =$1039/day

10. Method 2. Determining profit expected based on a realistic sales estimate. Based on the bookstore’s nearby owners and local customers information, owner projects the annuals sales to be $285000. Compute projected Income Statement: Net sales (100%) $285000 -COGS (61.4%) 174990 Gross Profit margin (38.6%) 110010 -Operating expenses (29.3%) 83505 Net Profit (before tax) (9.3%) $26505 If this amount is acceptable as a ROI of time & money in the business, he should proceed with his planning.

11. Creating Projected Financial Statements (cont’d) Pro Forma Balance Sheet-Liabilities Accounts Payable (supplier financing) Short-term Notes Payable Long-term Notes Payable

12. Creating Projected Financial Statements (cont’d) Pro Forma Balance Sheet-Assets Cash: Cash Requirement=Cash Expenses/AITR* *Average Inventory Turnover Ratio *Average Inventory Turnover RatioInventory: AITR=Cost of Goods Sold/Inventory Level

13. Pro forma Balance Sheet: An illustration ASSET: 1. Cash requirement =Cash expenses/ Avg Inventory Turnover =$80,940/ 3.5 times a year =$23,126 The book store owner found, depreciation is 0.9% of annual sales. Cash expense (annual)= operating expenses – annual depreciation =$ 83505 - $ 2565 = $ 80,940 2. Inventory: Avg Inventory Turnover= COGS/Inventory level Avg inventory turnover =3.5 times/ year; COGS= $174,990 Inventory Level = $174,990/ 3.5 = $ 49,997 Inventory turnover is a measure of the number of times inventory is sold or used in a time period (a year). Inventory level is the current amount of a product that a business has in stock.

14. Pro forma Balance Sheet: An illustration..cont. ASSET Based on various planning forms, she found that her estimate her fixed assets are: Fixtures $17,500 Office equipment 2,850 Computers/ Cash register 3,125 Signs 3,200 Miscellaneous 1,500 TOTAL $28,175 LIABILITIES The owner has no payable.

15. Sample Balance Sheet for the year ended 2016 : Liabilities Asset Current Liabilities Accounts Payable $0 Note Payable 0 Total Current Liabilities $0 Long-term Liabilities Note Payable $0 Total Liabilities 0 Net Profit (Loss) 58,748 Opening Capital 44,350 Total Liabilities & Owner’s equity $103,098 Current Assets Cash $23,126 Inventory 49,997 Miscellaneous 1,800 Total Current Assets $74,923 Fixed Assets Fixtures $17,500 Office equipment 2,850 Computers/ Cash register 3,125 Signs 3,200 Miscellaneous 1,500 Total Fixed Assets $28,175 Total Assets $103,098

16. Ratio Analysis A method of expressing the relationship between a y two accounting elements that allows business owners to analyze their companies’ financial performance

17. Ratio Analysis Categories: 1) Liquidity ratios 2) Leverage ratios 3) Operating ratios 4) Profitability ratios.

18. Ratio Analysis Liquidity Ratios: tell whether a small business will be able to meet its short-term obligations as they come due Current Ratio: measures a small firm’s solvency by indicating its ability to pay current liabilities out of current assets Current Ratio: measures a small firm’s solvency by indicating its ability to pay current liabilities out of current assets =Current Assets/Current Liabilities =$686,985/$367,850 =Current Assets/Current Liabilities =$686,985/$367,850 =1.87:1 Good: 2:1 Industry: 1.5:1 =1.87:1 Good: 2:1 Industry: 1.5:1

19. Ratio Analysis Liquidity Ratios (cont’d) Quick Ratio: a conservative measure of a firm’s liquidity, measuring the extent to which its most liquid assets (minus inventory) cover its current liabilities Quick Ratio: a conservative measure of a firm’s liquidity, measuring the extent to which its most liquid assets (minus inventory) cover its current liabilities =(Current Assets-Inventory)/Current Liabilities =(Current Assets-Inventory)/Current Liabilities =($686,750-$455,555)/$367,850 =($686,750-$455,555)/$367,850 =0.61:1 =0.61:1 Good: 1:1 Industry: 0.50:1 Good: 1:1 Industry: 0.50:1

20. Ratio Analysis Leverage Ratios: measure the financing supplied by a firm’s owners against that supplied by its creditors; they are a gauge of the depth of a company’s debt Debt Ratio: measures the percentage of total assets financed by a company’s creditors compared to its owners Debt Ratio: measures the percentage of total assets financed by a company’s creditors compared to its owners =Total Debt (Liabilities)/Total Assets =Total Debt (Liabilities)/Total Assets =($367,850+$212,150)/$847,655 =($367,850+$212,150)/$847,655 =0.681:1 =0.681:1 Good: 1:1 Industry: 0.64:1 Good: 1:1 Industry: 0.64:1

21. Ratio Analysis Leverage Ratios (cont’d) Debt to Net Worth Ratio: expresses the relationship between the capital contributions from creditors and those from owners and measures how highly leveraged the company is Debt to Net Worth Ratio: expresses the relationship between the capital contributions from creditors and those from owners and measures how highly leveraged the company is =Total Debt (Liabilities)/Tangible Net Worth =($367,850+$212,150)/($267,655- $3,500) =2.20:1 Industry: 1.90:1

22. Ratio Analysis Operating Ratios: help an entrepreneur evaluate a small company’s overall performance and indicate how effectively the business employs its resources Average Inventory Turnover Ratio: measures the number of times its average inventory is sold out, or turned over during an accounting period Average Inventory Turnover Ratio: measures the number of times its average inventory is sold out, or turned over during an accounting period =Cost of Goods Sold/Average Inventory =$1,290,117/($805,745+$455,455)/2 =2.05 times/year Industry: 4.0 times/year

23. Industry MedianSam’s shopRatios 1.50:1 0.50:1 0.64:1 1.90:1 2.0:1 4.0 times/year 19.3 days 43 days 2.7:1 10.8:1 7.6% 12.6% 1.87:1 0.63:1 0.68:1 2.20:1 2.52:1 2.05 times/year 50 days 59.3 days 2.21:1 5.86:1 3.24% 22.65% 1. Liquidity Ratio: 1.1 Current ratio 1.2 Quick ratio 2. Leverage ratio: 2.1 Debt ratio 2.2 Debt to net worth ratio 2.3 Times interest earned 3. Operating ratio: 3.1 Avg inventory turnover ratio 3.2 Avg collection period ratio 3.3 Avg payable period ratio 3.4 Net sales to total assets ratio 3.5 Net sales to working capital ratio 4. Profitability ratio: 4.1 Net profit on sales ratio 4.2 Net profit to equity ratio

24. Break-even Analysis Break-even point: the level of operation (sales dollars or production quantity) at which a company neither earns a profit or incurs a loss Break-even point: the level of operation (sales dollars or production quantity) at which a company neither earns a profit or incurs a loss Fixed expenses: expenses that do not vary with changes in the volume of sales or production Fixed expenses: expenses that do not vary with changes in the volume of sales or production Variable expenses: expenses that vary directly with changes in the volume of sales or production (raw materials cost, sales commissions) Variable expenses: expenses that vary directly with changes in the volume of sales or production (raw materials cost, sales commissions)

25. Break-Even Analysis Calculating the Break-Even Point B.E sales ($)= Total Fixed cost/ Contribution margin as % of sales *contribution margin=1-(variable cost/ sales revenue)% Step 1: Estimated net sales $950,000, cost of goods sold $646,000 and total expenses $236,000 Step 1: Estimated net sales $950,000, cost of goods sold $646,000 and total expenses $236,000 Step 2: Categorize the total expenses into fixed and variable ($177,375+$705,125) Step 2: Categorize the total expenses into fixed and variable ($177,375+$705,125) Step 3: Calculate ratio of variable expenses to net sales ($705,125/$950,000)=74%, Contribution margin is 26% Step 3: Calculate ratio of variable expenses to net sales ($705,125/$950,000)=74%, Contribution margin is 26% Step 4: Compute Break-even Sales: Step 4: Compute Break-even Sales: =Total Fixed Cost/Contribution Margin as % of sales =$177,375/0.26 =$682,212

26. Break-even Analysis Want to do better than Break-even Sales Want to do better than Break-even Sales =(Total Fixed Expenses + Desired Profit)/Contribution Margin as % of sales =($177,375+$80,000)/0.26 =$989,904

27. Break-even Analysis Break-even point in units Break-even point in units = Total Fixed Costs/per unit contribution margin =Total Fixed Costs/(Sale Price per unit- Variable cost per unit) =$390,000/($17.50-$12.10)=$390,000/$5.40 =72,222

28. Break-even Analysis If it wants to earn $80,000 profit: If it wants to earn $80,000 profit: = Total Fixed Costs+ Desired net income/per unit contribution margin =Total Fixed Costs + Desired net income/(Sale Price per unit-Variable cost per unit) =$390,000+80,000/($17.50-$12.10)=$470,000/$5.40 =87,037 units, which would require 87037*$17.50 per unit=$1,523,147.5 in sales 87037*$17.50 per unit=$1,523,147.5 in sales

29. Break-even Analysis Constructing a Break-even Chart Step 1: On Horizontal axis, mark a scale to plot sales volume Step 1: On Horizontal axis, mark a scale to plot sales volume Step 2: On Vertical axis, mark a scale to plot income and expense in dollars Step 2: On Vertical axis, mark a scale to plot income and expense in dollars Step 3: Draw fixed expense line parallel to horizontal axis beginning at Point A Step 3: Draw fixed expense line parallel to horizontal axis beginning at Point A Step 4: Draw a total expense line (upward sloping) where FC insects vertical axis (Arbitrarily choosing sales level, total expense at that sales level is Point B) Step 4: Draw a total expense line (upward sloping) where FC insects vertical axis (Arbitrarily choosing sales level, total expense at that sales level is Point B) Step 5: Draw a 45 degree revenue line (Total sales =total income=point C) Step 5: Draw a 45 degree revenue line (Total sales =total income=point C) Step 6: Locate break-even point: intersection of revenue line and total expense line Step 6: Locate break-even point: intersection of revenue line and total expense line

30. Break-even Analysis Point A: Fixed expense line $177,375 Point A: Fixed expense line $177,375 Point B: Total Expense at sales level of $950,000 = $177,375+(.74*$950,000) =$880,375 Point B: Total Expense at sales level of $950,000 = $177,375+(.74*$950,000) =$880,375 Point C: Total sale= total income =$950,000 Point C: Total sale= total income =$950,000

32. Break-even Analysis Limitations: Limitations: -Fixed expenses remain constant for all sales levels -Variable expense change in direct proportion to changes in sales volume -Changes in sales volume have no effect on unit sales price