Chapter: 12BFM

Financial Management

12-1—Financial Management

• The moment a decision is made to start a business, financial planning begins.

• Questions to ask yourself:– How much money will be needed to start the

business?– Where will the financing come from?– How will adequate funds be obtained to operate

the business?

Financial Planning

• Many new businesses fail due to poor financial planning.

• Experts in business finance should be consulted to help the new business with its financial planning.

Ongoing OperationsRevenue

• All income that a business receives over a period of time revenue.

Expenses

• Are the costs of operating a business.

Basic Financial Equation

• Every business is guided by the basic financial equation.

• Revenue-Expenses = Profit or Loss

• Profit is when revenue is greater than expenses.

• Loss is when expenses exceed revenue.

Question???

• If a company’s annual revenue is $2 million and expenses were 1.5 million, did the business make a profit or a loss?

Ongoing Operations

• All managers are responsible for the cost of the part of the business they manage.

• Why should employees also care if a business is making money? – The profitability of the business is directly

linked to the number of employees and the wages the business can pay.

Business Expansion• Successful businesses expand to

be able to:–Serve more customers–Reach unserved markets–Sell new products

Business Expansion• Business expansion calls for research to

develop new products

• Most expansion plans occur over a long and can cost thousands of dollars.

• Each time business expansion is anticipated, careful financial planning must be completed.

Developing Business Budgets

• A budget provides detailed plans for the financial needs of individuals, families, and businesses.

Developing Business Budgets

• A business budget has two main purposes:– 1. Anticipated sources and amounts of income.– 2. Predict the types and amounts of expenses for a

specific business activity or the entire business.

• The business must be able to identify and predict the amount of each source of income and each type of expense.

Small Business Administration

The Small Business Administration (SBA) provides many planning tools for new businesses.

Among those tools are guides to developing a budget and financial information to help the new business predict income and expenses.

Private Businesses

• Another source of information is private businesses that collect and publish financial information on similar businesses. Examples include Dun and Bradstreet, and Value Line.

• Some information is also available from business magazines include: Fortune, Forbes, Entrepreneur and The Wall Street Journal.

Budget Preparation

• The most important step in financial planning is developing a budget.

• A budget identifies where the business is going. It allows the owner to determine if the business is making progress toward its financial destination.

The Budgeting Process

• The budgeting process involves four fundamental steps.

1. Prepare a list of each type of income and expense that will be a part of the budget.

The Budgeting Process

• 2. Gather accurate information from business records and other information sources for each type of income and expense.

The Budgeting Process

3. Create the budget by calculating each type of income, expense, and the amount of net income or loss.

Types of Budgets

For every business, three particular budgets are essential. They are the start-up budget, the operating budget, and the cash budget.

Types of Budgets

• The start-up budget plans income and expenses from the beginning of a new businesses or a major business expansion until it becomes profitable.

• The operating budget describes the financial plan for ongoing operations the business for a specific period of time.

• Usually planned for 3 months, 6 months, or a year.

Types of Budgets

A cash budget is an estimate of the actual money received and paid out for a specific period.

A cash budget anticipates that cash will come into a business and that cash will be paid out during each week or month of operation.

Chapter: 12.2BFM

Financial Records and Financial Statements

Financial Records

• Financial records are used to record and analyze the financial performance of a business.

Types of Records• The following records are commonly

maintained to document the performance of a business.

• Asset records Tax records• Depreciation records Payroll records• Inventory records• Records of accounts• Cash records

Asset Records

• Asset records name the buildings and equipment owned by the business, their original and current value, and the amount owed if money was borrowed to purchase the asset.

Depreciation Records

• Depreciation records identify the amount assets have decreased in value due to their age and use.

Inventory Records

• Inventory records identify the type and number of products on hand for sale. Adequate records are critical to correctly determine the number of products sold, damaged, or lost and the current value of inventory.

Records of Accounts• Record of accounts identify all

purchases and sales made using credit.• Accounts payable identifies the

companies from which credit purchases were made and the amount purchases, paid, and owed.

Records of Accounts• Accounts receivable record identifies

customers that made purchases using credit and the status of each account.

Cash Records• Cash records list all cash received and

spent by the business.

Payroll records• Payroll records contain information

on all employees of the company, their compensation, and benefits.

Tax Records• Tax records show all taxes collected,

owed, and paid. As part of payroll, employers must withhold a percentage of employees’ salaries and wages for income taxes, Social Security, and Medicare taxes.

Maintaining Records• Business records have to be accurate

and should be kept up to date.• Technology is changing the way

financial information is now collected using point-of-production and point-of-sale technology using scanners, touch screens, and PDA’s.

Financial Statements• The three most important elements of

a company’s financial strength are its assets, liabilities, and owner’s equity.

Financial Statements

In simple terms, assets are what a company owns, liabilities are what a company owes, and owner’s equity is the value of the owner’s investment in the business.

Financial StatementsReports that sum up the financial performance of a business are financial statements.A company’s reports its assets, liabilities, and owner’s equity on the balance sheet.

Balance Sheet

The assets, liabilities, and owner’s equity for a specific date are listed on the balance sheet.The left side of the balance sheet lists the assets.

AssetsThere are two common divisions of assets.

Current assets include cash and those can be readily converted to cash such as inventory.Long-term assets (also known as fixed assets) are the assets with a lifespan of more than a year such as land, equipment, and buildings.

Liabilities

The right side of the balance sheet is divided into two sections.Liabilities are amounts owed by the business.

Current paid within a yearLong-term debts longer than a

year. (payments owed to banks)

Owner’s EquityFinally, owner’s equity is the value of the business after liabilities are subtracted from assets. It shows how much the business is worth on the date the balance sheet is provided.

Balance Sheet Example

Income StatementTo report revenue, expenses, and net income or loss from operations for a specific period, a business prepares an income statement.

Income StatementAn income statement usually covers six months or a year. , but may also encompass a shorter period such as a month.

Income StatementRevenue 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.

ExpensesExpenses are all of the costs of operating the business during the period.Expenses include such things as rent, supplies, inventory, payroll, and utilities.

Net Income/LossThe business has net income when revenue is greater than expenses.

A net loss occurs when expenses are greater than income.

Income Statement Example

Financial Statements

Business managers review financial statements carefully to determine how their businesses are performing.A business that is less profitable than similar businesses, or with lower sales or higher expenses, may have a hard time competing.

Chapter: 12.3BFM

Payroll Management

Payroll

• A payroll is the financial record of employee compensation, deductions, and net pay.

• A payroll system maintains information on each employee to be able to calculate the company’s payroll and to make the necessary payments.

Payroll

• Most businesses pay every employee on a weekly, bi-weekly, or monthly basis.

• A majority of employees in most businesses receive an hourly wage, but the wage rate may be different for each employee.

• The amount of salary for each person may be different. Some may earn additional payments in the form of commissions, bonuses, and profit sharing.

Payroll Compensation System

• Most businesses provide employees a range of benefits.

• Benefits may include insurance options, paid or unpaid vacation, sick leave, and personal leave, retirement plans, and education assistance.

• Many benefits are a part of the payments made to employees as a part of payroll.

Tax Records

• Businesses are responsible for making required federal and state payments for each employee.–Income Taxes–Social Security–Unemployment Taxes

Income Taxes

• The Federal government, most states, and some local governments require employers to withhold income tax from their employees’ pay.

• The taxes are based on the amount of wages and income and the number of employee dependents.

Social Security and Medicare

• These payments are often referred to as 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.

Unemployment Taxes

• Employers pay Federal Unemployment Tax (FUTA) to the unemployment insurance system.

• The amount owed is based on the business’ total employee wage. Many states also have their own unemployment taxes.

Payroll Systems

• Employers must withhold taxes from employee wages from employee wages and salaries as well.

• Businesses must prepare and maintain tax records.

• They also have to send require payments to the government on time.

Unemployment Taxes

• Employers pay Federal Unemployment Tax (FUTA) to the unemployment insurance system.

• The amount owed is based on the business’ total employee wage. Many states also have their own unemployment taxes.

Payroll Record

• The form used to track each employee’s pay history is a payroll record.

• Each payroll record holds the employee’s name, Social Security number, address, and other needed personal information.

• It also includes individual tax information and a record of benefits such as vacation and sick pay available and used.

Payroll Record

Payroll Check/Stub

Chapter: 12.4BFM

Financial Decision-Making

Understanding Financial Performance Ratios

• Managers use the financial elements found on the financial statements to calculate financial performance ratios.

• Financial performance ratios are comparisons of a company’s financial elements that indicate how well the business is performing.

Current Ratio

• Current assets compared to the current liabilities is the current ratio.

• Current assets are those that the business could convert to cash within one year.

• Current liabilities are all payments that the business must make within one year.

• The current ratio should be at least 1:1 for a healthy business. A 1:1 means that there are at least as many current assets as current liabilities.

Debt to Equity Ratio

• The company’s liabilities divided by the owner’s equity is the debt to equity ratio.

• The debt to equity ratio tells you how much the business is relying on money borrowed from others that will have to be paid back rather than provided by the owners.

• Most banks want to see a debt to equity ratio no higher than 2:1. To much debt puts a business at risk because it may have trouble meeting its obligations to its lenders.

Return on Equity Ratio

• The net profit of the business compared to the amount of owner’s equity is the return on equity ratio.

• The return on equity ratio shows the rate of return the owners are getting on the money they invested in the company.

• It should be compared to the return they could receive if they used their money in other ways such as savings, investing in other companies, or purchasing stocks and bonds.

Net Income Ratio

• The total sales compared to the net income for a period such as six months or a year is the net income ratio.

• The net income ratio show how much profit is being made by each dollar of sales for the period being analyzed.

Financial Performance Ratio

Financial Performance Ratio

Formula

Current Ratio Current AssetsCurrent Liabilities

Debt toEquity Ratio

Total LiabilitiesOwner’s Equity

Return onEquity Ratio

Net ProfitOwner’s Equity

Net Income RatioTotal Sales

Net Income

Making Financial Decisions

• The first step in financial decision-making is preparing a budget.

• Second, managers use the budget as a guide to the operations of the business.

• The final step is to make needed adjustments as needed.