Essential Standard 4.00
Essential Standard 4.00
Objective 4.01
Objective 4.01
Understand financial management.
Topics
Topics
Financial planning
Business budgets
Financial records and statements
Financial planning
Financial planning
Financial Planning
Financial Planning
Why should a business do financial planning?
◦ Reduces financial uncertainties
◦ Increases control of financial activities
◦ Provides a ‘map of finances’ for business
Financial Planning
Financial Planning
continued
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.
Business budgets
Business Budgets
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.
Business Budgets
Business Budgets
continued
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
What is
What is
income
income
?
?
Money received for goods or services
Net Sales
Revenue
Receipts
Earnings
Interest
What is
What is
expense
expense
?
?
Cost or charge incurred; a payment of money
Salaries Advertising
Utilities Telephone
Rent Repairs/
Maintenance
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 1 160,000 160,000 0 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 31 100,000 120,000 (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 23,000 0
Office Supplies 2,250 3,000 (750)
Insurance 3,900 3,900 0
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 1,000 250 Taxes & Licenses 11,700 10,000 1,700
Total Expenses 133,290 106,850 26,440
Startup Budget
March 17, 2011
Cash Needed % of Actual Cash % of % of to Start Total Spent Total Variance Total 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% 2,000 4.3% 0
Delivery expense 400 0.9% 1,000 2.1% (600) 19.0%
Supplies 500 1.1% 1,500 3.2% (1,000) 31.6%
Telephone 500 1.1% 500 1.1% 0
Other utilities 500 1.1% 760 1.6% (260) 8.2%
Insurance 600 1.4% 600 1.3% 0
Taxes, including social security 1,000 2.3% 1,000 2.1% 0
Interest 500 1.1% 500 1.1% 0
Maintenance 300 0.7% 300 0.6% 0
Legal and other professional fees 3,000 6.9% 3,300 7.0% (300) 9.5%
Miscellaneous 500 1.1% 500 1.1% 0
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) 31.6%
Decorating and remodeling 1,000 2.3% 1,200 2.6% (200) 6.3%
Installation charges 500 1.1% 600 1.3% (100) 3.2%
Starting inventory 5,000 11.4% 4,000 8.5% 1,000 -31.6%
Deposits with public utilities 1,000 2.3% 1,200 2.6% (200) 6.3%
Legal and other professional fees 500 1.1% 500 1.1% 0
Licenses and permits 500 1.1% 500 1.1% 0
Advertising and promotion for opening 500 1.1% 500 1.1% 0
Cash 750 1.7% 750 1.6% 0
Other 200 0.5% 200 0.4% 0
Subtotal $19,950 45.6% $20,450 43.6% ($500) 15.8%
14
SAMPLE Operating Budget
July 1, 2004 to June 30, 2005 Income Membership dues - 35 @ $25.00 $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 -35 @$5.00 $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
Financial
Financial
records and statements
Financial Records and
Financial Records and
Statements
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 and
Financial Records and
Statements
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
Financial Records and
Financial Records and
Statements
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
Financial Records and
Financial Records and
Statements
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
What are
What are
assets
assets
?
?
Assets are things that a business
(or person) owns
Examples: cash, inventory, real
estate, equipment, accounts receivable
What are
What are
liabilities
liabilities
?
?
Liabilities are things that a
business (or person) owes
Examples: debt, accounts
What is owner
What is owner
’
’
s equity?
s equity?
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
Financial Records and
Statements continued
Statements continued
What are financial statements?
Financial statements provide a picture of the financial
Financial Records and
Financial Records and
Statements continued
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
Revenue vs. Expenses
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,
Revenue vs. Expenses
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.
Sample Income Statement
Sample Balance Sheet
Sample Balance Sheet
Financial performance
Financial performance
ratios
Financial Performance
Financial Performance
Ratios
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
Financial Performance Ratios
Financial Performance Ratios
continued
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
Financial Performance Ratios
Financial Performance Ratios
continued
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.
Current Ratio and Debt to Equity Ratio
Current Ratio and Debt to Equity Ratio
Current 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. Calculation:
External Equities / Internal Equities Equity share capital
Capital reserve
Profit and loss account 6% debentures
Sundry creditors Bills payable
Financial Performance Ratios
Financial Performance Ratios
continued
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.
Financial Performance Ratios
Financial Performance Ratios
continued
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
Return on Equity Ratio and Net Income
Return on Equity Ratio and Net Income
Ratio
Ratio
Return on Equity 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. Calculation:
Net sales = (520,000 – 20,000) = 500,000
Net Profit Ratio = [(40,000 / 500,000) × 100] = 8%
Ratios
Ratios
Financial
Performance Ratio
Formula
Current Ratio Current Assets/Current Liabilities
Debt to Equity Ratio
Total Liabilities/Owners’ Equity
Return on Equity
GROSS vs. NET
GROSS vs. NET
Gross means amount before any
expenses are deducted
Net means amount after
expenses are deducted
Discrepancies
Discrepancies
Discrepancies are differences
between actual and budgeted performance.