1. Understanding the role of finance in business.
Essential Standard 4.00
Understanding the role of finance in business.

2. Understand financial management.
Objective 4.01
Understand financial management.

3. Topics Financial planning Business budgets
Financial records and statements
Financial performance ratios

4. Financial planning

5. 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.

6. Financial Planning continued
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.

7. Business budgets

8. 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.

9. Business Budgets continued
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.

10. What is income? Money received for goods or services Net Sales Revenue
Receipts
Earnings
Interest

11. What is expense? Cost or charge incurred; a payment of money
Salaries Advertising
Utilities Telephone
Rent Repairs/Maintenance
Insurance Taxes

12. Sample Company Budget January 1, xxxx to December 31, xxxx
Category
Actual
Budget
Difference
Inflows
Net Sales
385,400
300,000
85,400
Cost of Goods
 Merchandise Inventory, January 1
160,000
 Purchases
120,000
90,000
30,000
 Freight Charges
  2,500
  2,000
  500
 Total Merchandise Handled
282,500
252,000
30,500
 Less Inventory, December 31
100,000
(20,000)
  Cost of Goods Sold
182,500
132,000
50,500
  Gross Profit
202,900
168,000
34,900
Interest Income
 500
 700
 (200)
Total Income
202,500
168,700
33,800
Expenses
Salaries
68,250
45,000
23,250
Utilities
5,800
4,500
1,300
Rent
23,000
Office Supplies
2,250
3,000
(750)
Insurance
3,900
Advertising
8,650
9,000
(350)
Telephone
2,700
2,300
400
Travel and Entertainment
2,550
2,000
550
Dues & Subscriptions
1,100
1,000
100
Interest Paid
2,140
2,500
(360)
Repairs & Maintenance
1,250
250
Taxes & Licenses
11,700
10,000
1,700
Total Expenses
133,290
106,850
26,440
Net Income
$69,210
$61,850
$7,360

13. Startup Budget March 17, 2011 Cash Needed % of Actual Cash to Start
Actual Cash
to Start
Total
Spent
Variance
Monthly Costs
Salary of owner-manager
$6,000
13.7%
$6,500
13.9%
($500)
15.8%
All other salaries and wages
7,000
16.0%
7,100
15.1%
(100)
3.2%
Rent
1,000
2.3%
900
1.9%
100
-3.2%
Advertising
2,000
4.6%
4.3%
Delivery expense
400
0.9%
2.1%
(600)
19.0%
Supplies
500
1.1%
1,500
(1,000)
31.6%
Telephone
Other utilities
760
1.6%
(260)
8.2%
Insurance
600
1.4%
1.3%
Taxes, including social security
Interest
Maintenance
300
0.7%
0.6%
Legal and other professional fees
3,000
6.9%
3,300
7.0%
(300)
9.5%
Miscellaneous
Subtotal
$23,800
54.4%
$26,460
56.4%
($2,660)
84.2%
One-Time Costs
Fixtures and Equipment
$10,000
22.9%
$11,000
23.4%
($1,000)
Decorating and remodeling
1,200
2.6%
(200)
6.3%
Installation charges
Starting inventory
5,000
11.4%
4,000
8.5%
-31.6%
Deposits with public utilities
Licenses and permits
Advertising and promotion for opening
Cash
750
1.7%
Other
200
0.5%
0.4%
$19,950
45.6%
$20,450
43.6%
Totals
$43,750
100%
$46,910
($3,160)

14. SAMPLE Operating Budget
July 1, 2004 to June 30, 2005
Income
Membership dues - $ $875.00
Fund-raiser $100.00
Contest entry award $25.00
Aluminum can sales $27.00
T-shirt sales $468.00
Parties $200.00
Total Income $1,695.00
Expenses
Parties $710.00
Intramurals $15.00
Gifts $55.00
Refreshments $100.00
National/regional dues $175.00
Fund-raiser $44.00
T-shirts $450.00
Picnic $99.00
Office supplies/duplicating $28.00
State & County sales tax $19.00
Total Expenses $1,695.00
AVAILABLE FUNDS

15. Financial records and statements

16. 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.
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.

17. 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

18. 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

19. 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.

20. What are assets? Assets are things that a business (or person) owns
Examples: cash, inventory, real estate, equipment, accounts receivable

21. What are liabilities?
Liabilities are things that a business (or person) owes
Examples: debt, accounts payable, loans

22. What is owner’s equity?
Owner’s equity is the value of the owners’ investment in the business
Value of business after liabilities are subtracted from assets

23. Financial Records and Statements continued
What are financial statements?
Financial statements provide a picture of the financial performance of a business
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.

24. Financial Records and Statements continued
What is the difference between a balance sheet and an income statement?
Balance sheet includes assets, liabilities and owner’s equity
Income statement includes sales, expenses and net profit/net loss

25. Revenue vs. Expenses
Revenue is all income received by the business during the period. Sources of income include the sale of products and services, plus interest earned from investments.
Expenses are all the costs incurred by the business during the period. Expenses include operations, purchase of equipment, supplies, inventory, payroll and taxes.

26. Revenue vs. Expenses
The business has net income when revenue is greater than expenses.
The business has net loss when expenses are greater than revenue.

27. Sample Income Statement

28. Sample Balance Sheet

29. Financial performance ratios

30. 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

31. Financial Performance Ratios continued
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.
Normally, the higher the ratio, the more favorable it is for the company.

32. Financial Performance Ratios continued
Debit to equity ratio
Equals total liabilities/owner’s equity
Shows how much the business relies on money borrowed externally which will have to be paid back versus money provided by the owners. Ideally, this ratio should be less than 2.0.
Normally, the lower this ratio, the more favorable it is for the company.
Too much debt puts a business at risk because it may have trouble meeting its obligations to its lenders.

33. Current Ratio and Debt to Equity Ratio
Current assets are $1,200,000 and total current liabilities are $600,000.
Calculate current ratio.
Calculation:
Current Ratio = 1,200,000 / 600,000
= 2 or
1200,000 : 600,000
2 : 1
Debt to Equity Ratio
Required: Calculate debt to equity ratio.
External Equities / Internal Equities
= 1,200,000 / 1,800,000
= 0.66 or 4 : 6
Equity share capital Capital reserve Profit and loss account 6% debentures Sundry creditors Bills payable Provision for taxation Outstanding creditors
1,100, , , , , , , ,000

34. Financial Performance Ratios continued
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.
Normally, the higher the ratio, the more favorable it is for the company.

35. Financial Performance Ratios continued
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.
Normally, the lower the ratio, the more favorable it is for the company, as it takes less in sales to generate net income.

36. Return on Equity Ratio and Net Income Ratio
Return on equity or ROE can be calculated as,
Calculate return on equity share capital from the following information:
Equity share capital ($1): $1,000,000; 9% Preference share capital: $500,000; Taxation rate: 50% of net profit; Net profit before tax: $400,000.
Calculation:
Return on Equity Capital (ROEC) ratio = [(400,000 − 200,000 − 45,000) / 1,000,000 )× 100]
= 15.5%
Net Income Ratio
Formula:
Net Profit Ratio = (Net profit / Net sales) × 100
Example:
Total sales = $520,000; Sales returns = $ 20,000;  Net profit $40,000
Calculate net profit ratio.
Net sales = (520,000 – 20,000) = 500,000
Net Profit Ratio = [(40,000 / 500,000) × 100]
= 8%

37. Ratios Financial Performance Ratio Formula Current Ratio
Current Assets/Current Liabilities
Debt to Equity Ratio
Total Liabilities/Owners’ Equity
Return on Equity Ratio
Net Profit/Owners’ Equity
Net Income Ratio
Total Sales/Net Income

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

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