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A crash course in financial management for startup businesses Presented by:
Matt H. Evans SCORE Mentor
Finance 101 for Startups Outline
• Module 1 – How Accounting Works
• Module 2 – Reading the Financial Statements
• Module 3 – Analyzing the Financial Statements
• Module 4 – Additional Financial Analysis
• Module 5 – Evaluating Long Term Investments
• Module 6 – Some Advanced Concepts
1
Workshop Roadmap Overview
2
Accounting
Financial Statements
Analyze the Financials
Start with Accounting
Generate the Financial Statements
Apply Analytical Tools and Techniques
Make Objective Decisions per the Numbers
Manage the Business
You as the Business Owner should spend time measuring
and managing the business based on the numbers
Module 1 How Accounting Works
3
Overview of how the accounting process works at
a detail transaction level
Think in Terms of Your Check Book Module 1
4
• All transactions pass through your Check Book
• All transactions must be recorded
• Businesses have a wide range of transactions:
- Customers buy your products or services = Cash
Inflows
- Vendors and Employees must be paid = Cash Outflows
Cash Inflows
(Deposits)
Cash Outflows
(Checks)
Accrual Accounting is Preferred Module 1
5
Most transactions are cash basis (pass through your cash
account), but . . .
• Accrual Accounting recognizes revenues when earned before
you collect the cash – Accounts Receivable Account
• Accrual Accounting recognizes expenses when incurred
before you make payment – Accounts Payable Account
• Cash Basis – Only post transactions when they go in and
out of your Check Book
• Tracking – Make sure you can control and track the
money you owe others in the future and collect all money
owed to you (customers pay on time when due).
Simple Cash Basis Accounting Module 1
6
Simple Spreadsheet for Cash Basis Accounting
Year:
Date Description Name Amount Category RefRevenues: (Cash Collected from Sales to Customers)
2/8/2018 Sold 18 bars soap at Eastern Market Various Walk By Traffic 54.00$ Sales Revenue
2/17/2018 Sold 20 bars soap to Rosa Ela Shop Rosa Ela Shop in College Prk 40.00$ Sales Revenue
2/22/2018 Sold 22 bars soap at Dupont Circle Various Walk By Traffic 66.00$ Sales Revenue
Feb-18 Online Orders of Soap - Etsy Various per Etsy 22.00$ Sales Revenue
TOTAL REVENUES 182.00$
Expenses: (Cash Paid for all business related expenses)1/6/2018 Soap Materials Sarah's Craft House (110.09)$ Materials Expense
1/15/2018 Booth Materials for Markets M-Displays Inc (75.00)$ Marketing Expense
1/22/2018 Promotion Flyers Office Max (36.55)$ Marketing Expense
2/6/2018 License Fee to County DC Dept of Cons / Reg Affairs (115.00)$ Legal Expenses
TOTAL EXPENSES (336.64)$
PROFIT OR (LOSS) (154.64)$
Five Major Groups of Accounts Module 1
Businesses invest in assets two ways: Liabilities and Equity.
Assets exist for one single reason: To Generate Revenues
1. Assets – Resources of the Business
2. Liabilities – Obligations
3. Equity – Investments by Owners
4. Revenues – Inflows from Sales
5. Expenses – Outflows for Costs
Balance Sheet
Income Statement
The Accounting Model can be summarized through two equations: Assets = Liabilities + Equity Revenues – Expenses = Profit or (Loss)
7
General Ledger Accounts Module 1
Chart of Accounts is the structure by which all transactions
are categorized and reported by the business
Cash Money in the bank
Accounts Receivable Amounts owed to the company for sales
Inventory Pants, Shirts, Hats, Shoes, Socks, Belts, etc.
Prepaid Expenses Amounts paid in advance
Furniture and Fixtures Storefront assets such as tables, racks, chairs, etc.
Machinery and Equipment Property used to manufacture clothing (Sewing Machines)
Accounts Payable Amounts that must be paid to vendors / suppliers
Loans Payable Amounts due to banks
Long Term Debt Amounts due to investors or bank against long term assets
Owners Capital Account Amount invested by the owner of the business
Retained Earnings Profits held by the business for reinvesting
Sales Revenue Amount of revenues from selling products / services
Cost of Goods Sold Cost of inventory that has been sold
Administrative Expense Cost of office support personnel
Selling and Marketing Expense Advertising, Sales Commissions, Trade Show Displays, etc.
Utility Expense Gas, Water & Electric expenses
Depreciation Expense Expense a portion of the cost of a long term asset
Assets
Liabilities
Equity
Revenues
Expenses
8
Posting Entries - Debits vs. Credits
9
Module 1
Account Type DEBIT CREDIT
Asset Increase Decrease
Liability Decrease Increase
Equity Decrease Increase
Revenues Decrease Increase
Expenses Increase Decrease
Every transaction has two sides in the world of accounting – Debit (Left Side) and Credit (Right Side). Everything must balance out!
Most Transactions Go Thru the Cash Account Module 1
10
1-6-2014 Purchase office supplies
1-1-2014 Beginning Balance
Cash
1-16-2014 Run Bi Weekly Payroll
1-12-2014 Deposit payment from customer
1-26-2014 Pay Monthly Electric Bill
1-22-2014 Insurance Premium Paid
$ 4,220.55
$ 142.20
1-31-2014 Ending Balance
$ 3,600.00
$ 2,640.00
$ 265.00
$ 516.30
$ 4,257.05
Debit (Left) Credit (Right)
Let’s walk through a few accounting entries as it relates to the Cash Account
The Overall Process Module 1
11
Accounting
System
Financial
Statements
End of Period
Accrual Entries
Transactions
(Mostly Cash Basis)
Post to General
Ledger Accounts
Accounting is a very iterative process that captures transactions (inputs)
to generate Financial Statements (outputs)
Balance
Sheet
Income
Statement
Economic Activity of the
Business
Exercise 1 – Accounting Entries Module 1
12
Let’s go through a startup business and see how accounting transactions get posted over time Three phases take place over time when starting a business: 1. Fund the Business – Financing Transactions 2. Acquire the Right Mix of Assets to Generate Revenues –
Investment Transactions 3. Generate Revenues and Expenses – Operating Transactions
Someone in your business must be responsible for
posting accounting transactions on a regular basis
Module 2 Financial Statements
13
Read and understand the three financial
statements associated with your business
Three Financial Statements Module 2
• Financial condition of a company at a given point in time
• Consists of three components: Assets, Liabilities and Owners Equity
• Profit or Loss of a company over a period of time
• The critical indicator of company performance!
• Consists of two components: Revenues and Expenses
• Sources and uses of cash over a period of time
• Consists of three activities: Operating, Investing, and Financing
Income
Statement
Statement of Cash Flow
Balance
Sheet
14
Balance Sheet – Asset Side Module 2
These accounts should Turnover in the Current Year
15
Long term investments in the business should generate positive returns
Current Assets
Cash 850
Receivables 2,300
Inventories 6,600
Prepaid Insurance 400
Total Current Assets 10,150
Long Term Assets
Furniture and Fixtures 1,950
Vehicle 12,400
Special Equipment 6,450
Intangible - Patent 1,200
Total Long Term Assets 22,000
Total Assets 32,150
Group assets between current and long term when presenting the Balance Sheet
Balance Sheet – Liabilities and Equity Side Module 2
Pay within the next 12 months
16
Be careful – High debt level equates to a high risk of default
Currrent Liabilities
Accounts Payable 1,760
Salaries Payable 1,500
Short Term Loan Payable 3,500
Total Current Liabilities 6,760
Long Term Liabilities
Bank Loan on Vehicle 9,800
Total Long Term Liabilities 9,800
Total Liabilities 16,560
Equity
Owners Capital Account 14,690
Retained Earnings 1,100
Owners Withdrawal (200)
Total Equity 15,590
Total Liabilities + Equity 32,150
Group liabilities between current and long term when presenting the Balance Sheet
Income Statement Module 2
Operating Expenses
Non-Operating Expenses
Non-Operating line items add “noise” to Income
Statements – they can be both revenue and expense 17
Sales Revenues 6,800
Cost of Goods Sold 2,600
Gross Profit 4,200
Selling and Marketing Expenses 1,824
Rent and Utilities 2,600
Administrative Support Expenses 750
Other Operating Expenses 300
Operating Income (1,274)
Interest Expense 81
Special Legal Fee 300
Net Income (1,655)
TOP LINE
BOTTOM LINE
Distinguish Operating vs. Non Operating when presenting the Income Statement
Reporting Cash Flows – Three Categories Module 2
18
Operating Activities
• Cash received from customers
• Payments made to vendors and employees
• Tax payments, rent payments, utilities, etc.
Investment Activities • Invest in Real Estate
• Sell Off Equipment
Financing Activities • Secure Long Term Financing (Loan)
• Distribute Income to Owners
For financial reporting purposes, cash flows have three categories:
Statement of Cash Flow Module 2
You eventually want your business to be cash flow positive from its operations so you can avoid having to finance day to day operations
19
Cash Flow from Operations
Net Income 2,300
Add back Depreciation 800
Changes in Current Assets and Liabilities
Receivables 900
Payables (1,200)
Inventories 3,200
Cash from Operations 6,000
Cash Flow from Investments
Purchase of Plant Equipment (7,800)
Sale of Fixed Assets 1,300
Cash from Investments (6,500)
Cash Flow from Financing
Proceeds from Issuing Debt 2,500
Pay down bank loan (1,190)
Capital contribution by owner 2,000
Cash from Financing 1,310
Change in Cash for Year 810
Exercise 1 – Generate Financial Statements Module 2
20
Now let’s close out the accounting period and generate financial statements per the balances that are outstanding in the various general ledger accounts The goal is to continually review the financial statements on a regular basis (monthly or at least quarterly) to assess where we stand and take corrective action
Sales is the most important enabler for producing
favorable financial results. You must spend time and
effort on acquiring customers – selling!
Module 3 Analyze the Financials
21
Apply analytical techniques to your financial
statements to better assess where you stand
Financial Terminology Module 3
22
Debt – Liabilities such as Loans, Mortgages, Bonds, and Commercial Paper (large public corporations). High debt levels equates to high risk.
Equity – The amount of funds invested by owners of the business + profits that are retained by the business for future growth.
Liquidity – The ability of a company to convert assets into cash for meeting short-term obligations
Leverage – How a company finances its assets; debt vs. equity
Net Income or Profits – The residual income remaining after all expenses.
Rate of Return – How much return does the investment generate for the business; residual income after all costs. It is important for long term assets to generate positive returns.
Turn Over – The ability of a company to turn over and convert an asset into something else, such as sales or cash. It is important to turn over current assets into cash.
Working Capital – The funds available to the business within the current operating cycle, expressed as current assets in excess of current liabilities.
Every business owner should be financially smart. This will require an understanding of some important concepts such as:
Another Important Concept is Turnover Module 3
Any asset that is “current” needs to turnover – the shorter the cycle the better which in turn reduces the need to finance the current operations of the business.
Accounts
Receivable
Cash
Inventory
Sale
Eventually everything will flow through your cash account!
23
Three Useful Analytical Techniques Module 3
24
Ratio Analysis • Divide one number by another number • Easy to benchmark and understand performance Horizontal Analysis • Track Trends over Time • Key Trends include Sales Revenues, Net Income, Debt Levels Vertical Analysis • Track Relationships (between accounts) over Time • Monitor proportion of debt and equity to assets – too much debt equates to
higher risk • Monitor proportion of non-operating expenses to operating expenses – most
of your costs should be operating with minimal non-operating expenses
Analyze a set of financial statements:
Four Types of Ratios Module 3
25
Liquidity Ability to meet short-term
obligations of the business
Leverage Degree to which assets are
financed by debt
Asset Management Management’s ability to manage
assets
Profitability Degree of profitability generated
You need both a Balance Sheet and Income Statement
in order to calculate ratios
Ratios help you measure the following:
Liquidity – Meet Short Term Obligations Module 3
26
Measures the ability of a company to meet its short term obligations
Current Ratio =
Quick Ratio =
Current Assets
Current Liabilities
Current Assets - Inventory
Current Liabilities
These ratios should be greater than 1.0 since you have to
have sufficient liquid assets that cover your current
liabilities
Asset Management Ratios Module 3
27
Use Ratios to measure how well a company manages its current assets
Accounts Receivable Turnover
Sales
Accounts
Receivable
Days Held in Accounts Receivable
A / R Turnover
365 Days
Inventory Turnover
Cost of Goods Sold
Inventory Days Held in Inventory
365 Days
Inventory Turnover
Measuring Risk (Debt Levels) Module 3
28
Measure the degree to which the company is leveraged in terms of debt and equity
Debt to Equity
Debt to Assets
Total Liabilities
Owners Equity
Total Liabilities
Total Assets
Greater than 100% means company is using more debt than equity – more risk to the company
Greater than 50% means the company is using more debt than equity – more risk to the company
Calculate Your Margins Module 3
29
Profit Margin
Net Income
Sales
Operating Margin Sales
Operating Income
Return on Assets
Net Income
Total Assets (1)
Gross Margin
Gross Profit
Sales
(1) Average balances for the year are often used
Know your margins – every industry has an approximate
margin it should generate
Use Ratios to measure profitability and benchmark to your respective industry
Horizontal - Track Your Historical Trends Module 3
30
Another easy way to read and understand financial results is to
look at trends from period to period
2004 2005 2006
Sales Revenues $ 120,000 $ 135,000 $ 146,000
Operating Expenses $ 68,000 $ 73,000 $ 78,000
Net Income $ 22,000 $ 26,000 $ 29,000
$-
$20,000
$40,000
$60,000
$80,000
$100,000
$120,000
$140,000
$160,000
2004 2005 2006
Sales Revenues
Operating
Expenses
Net IncomeIt can be easier to read trends when you show it graphically
Vertical Analysis – Income Statement Module 3
31
Express the balances as a percentage of Total Revenues to size up the breakdown of all line items on the Income Statement
%
Revenues Breakdown
Sales Revenues 4,000.00$ 100%
Total Revenues 4,000.00
ExpensesCost of Goods Sold 1,320.00 33%
Office Supply Expense 680.90 17%
Depreciation Expense 458.33 11%
Interest Expense 278.96 7%
Tax Expense 312.50 8%
Total Expenses 3,050.69 76%
Net Income 949.31$ 24%
Vertical Analysis – Balance Sheet Module 3
32
Percentage Breakdown of all assets
Assets %
Current Assets Breakdown
Cash 32,714.60$ 32%
Accounts Receivable -$ 0%
Inventory 9,680.00$ 9%
Total Current Assets 42,394.60 41%
Long Term Assets
Furniture & Fixtures 6,104.50 6%
Warehouse Facility 55,000.00$
Less Accumulated Depreciaiton 458.33$
Net Warehouse Facility 54,541.67 53%
Total Long Term Assets 60,646.17 59%
Total Assets 103,040.77 100%
Minimize and Turnover
Generate a Return
Vertical Analysis – Balance Sheet Module 3
33
Percentage Breakdown of all liabilities and equity
Liabilities
Current Liabilities
Accounts Payable 591.46 1%
Mortgage Payable - Current 305.81 0%
Total Current Liabilities 897.27 1%
Long Term Liabilities
Mortgage Payable 51,194.19 50%
Total Long Term Liabilities 51,194.19 50%
Total Liabilities 52,091.46 51%
EquityCapital Account 50,000.00 49%
Retained Earnings 949.31 1%
Total Equity 50,949.31 49%
Total Liab + Equity 103,040.77 100%
Benchmark Your Performance Module 3
34
Per the Arlington Public Library, two sources that can help you benchmark are:
RMA (Risk Management Association) Annual Statement Studies – Financial Ratios
2017 Almanac of Business and Industrial Financial Ratios, 48th Edition
1. Know your NAICS Code: 448110 = Men’s Clothing Retail 448120 = Women’s Clothing Retail 448140 = Family Clothing Retail 448150 = Clothing Accessories 448210 = Shoes Retail 448310 = Jewelry Retail 2. Know your size by total assets and total sales
1. Know your Industry Code: 315215 = Clothing Manufacturing 448115 = Clothing Retail Store 2. Know your size by total assets and total sales
http://www.bizstats.com/
Here are some online sources:
https://www.sba.gov/tools/sizeup
Exercise 2 – Calculate Ratios Module 3
35
Let’s go through an example of calculating three ratios using the financial statements that we compiled from Exercise 1 This is how you gain insights into your financial performance – you cannot just read the financial statements; you need to analyze the financials!
Ratios are the most common technique used to analyze a set of financial statements
36
Take a Break
Module 4 Additional Analysis
37
Additional concepts related to financial analysis
Cost Analysis Module 4
Sales Volume
Cost Variable
Fixed
Variable Cost – Varies or changes with changes in sales. Includes production labor, raw materials and various discretionary items such as advertising.
Fixed Cost – Remains the same regardless of activity levels. Tends to be long-term commitments or non-discretionary items such as Rent, Insurance, Interest, Depreciation and Senior Management Salaries.
A scalable business is one where you increase the volume sold and you see lower marginal cost. If your sales grow and your total cost continue to go up, you do not have a scalable business
38
Know Your Breakeven Point Module 4
Simple Concept: How much business do I have to do to breakeven (recover all of my costs)?
Breakeven Volume = Fixed Costs / (Sales Price – Variable Cost per Unit)
Breakeven Sales Amount = Fixed Costs / Contribution Margin Ratio
Contribution Margin Ratio = (Sales Price – Variable Cost) / Sales Price
EXAMPLE: Sales Price = $ 45.00 per shirt | Materials = $ 6.00 per shirt + Labor = $ 9 per shirt + Variable Overhead = $ 3 per shirt = Total Variable Cost per Unit of $ 18.00
$ 70,470 of costs are incurred no matter how much you sell
Breakeven Units = $ 70,470 / ($ 45.00 - $ 18.00) = 2,610 shirts must be sold
Contribution Margin = $ 27.00 / $ 45.00 = 60%
Breakeven Revenues = $ 70,470 / .60 = $ 117,450 (2,610 units x $ 45.00)
39
Relevant Cost = Variable Cost Module 4
40
Make or Buy Decision Analysis: Make price of $ 68.95 vs. Buy price of $ 60.00
Cost to Manufacture Products
Direct Materials 18.20$
Direct Labor 21.60$
Overhead - Variable 12.60$
Overhead - Fixed * 16.55$
Total 68.95$
* no change in Fixed OH anticipated since we have
unused surplus capacity for making products
Make or Buy Differential Analysis
Purchase Price for Products 60.00$
Cost to Manufacture Products:
Direct Materials 18.20$
Direct Materials 21.60$
Overhead - Variable 12.60$
Total 52.40$
Cost Saved by Making 7.60$
When comparing profitability across products, projects,
customers or services, only the variable cost are relevant. The
fixed cost continue regardless of the decision.
Return on Investment (ROI) Module 4
41
Residual Benefits *
Total Amount Invested **
Looking at the overall business, ROI is usually expressed as Return on Capital or Return on Equity
ROI
Net Income
Average Equity for the Year
* Total Benefits less Total Amount Invested
** All costs to place the asset into service
Quantify the Future Benefits Module 4
Organizational Benefits Builds company reputation Creates new customer opportunities Fosters company vision and mission Improves market position relative to competitors Improves the ability to serve customers Increases competitiveness Financial Benefits Creates additional/new revenue Creates cost savings through tax avoidance Enables cost avoidance Faster return on investments Increases cash flow Increases profitability of existing products/services Increases revenue of existing sources Increases stock price/shareholder value Lowers cost of production Lowers cost of servicing
Operational Benefits Decreases employee work loads for undesirable work Eliminates non-value added activities Improves employee morale / team spirit Improves internal communication Improves use of workspace Reduces cycle time Reduces cycle time of production/process Reduces external inputs to processes Reduces person-hours Reduces process steps
Information Technology Benefits Decreases maintenance/support costs Improves application/system performance Improves application/system utilization rate Increases efficiency of support activities Increases productivity through automation Reduces paper documentation requirements Strengthens application/system security
Identifying costs (outflows) is fairly straight-forward. Trying to quantify the benefits (inflows) can be very challenging. Examples of benefits include:
42
Simple Example of ROI Module 4
43
Proposed new marketing program cost $ 200,000. It will give the company much more exposure to new potential customers. Past programs have proven to increase a company’s revenues by 5% over a three year period. What is the Rate of Return for this investment?
Step 1 - Quantify the Benefits: Current Annual Revenues are $ 1,600,000 x 5% = $ 80,000 benefits per year x 3 years = $ 240,000 Total Benefits Step 2 – Quantify all of the Costs: Total investment cost is up front, one time fee of $ 200,000 Step 3 – Calculate the ROI: Total Benefits of $ 240,000 - $ 200,000 costs = $ 40,000 residual benefits divided by $ 200,000 = 20% ROI
Returns Must Exceed Cost of Capital Module 4
44
All businesses have a cost of financing the business:
1. Cost of Debt – Interest Payments on Loans
2. Cost of Equity – Owners expect to get a return on what they’ve invested into the business
Cost of Capital = Cost of Debt + Cost of Equity
Cost of Capital Create Value
Destroy Value
Returns on Investment (ROI)
10%
12%
14%
16%
8%
6%
Module 5 Evaluating Long Term
Investments
45
How to evaluate the economics of a long term
investment
Contrasting Accounting vs. Finance Module 5
46
Accounting Finance
Historical Value (Looks Back) Future Values (Looks Forward)
Input = Transactions Input = Financial Statements,
Estimates, Analysis
Output = Financial Statements Output = Forecasts, Budgets, etc.
Not Analytical (Process
Transactions)
Very Analytical
Advocates Profits Advocates Creating Value
Enforce Rules and Comply Few Rules / More Creative
Short Term Focus Long Term Focus
What is the Value Today? Module 5
47
Accounting
Historical
Values
Constant Dollars –
does not change
over time
Why the differences in value (Accounting vs. Finance)?
1. Risk – I promise to pay you $ 100,000 five years from now!
2. Inflation - $ 100,000 five years from now will lose purchasing power!
3. Opportunity Cost – If you had $ 100,000 now (not five years from now), you could do something with it – lost opportunity!
Finance
Present
Values
What is the value
today?
Future
Values
What is the value
tomorrow?
48
Three Economic Criteria Module 5
Three important economic indicators in finance for evaluating long term investments:
1. Return on Investment – We discussed this earlier > Investors must earn a rate higher than the cost of capital; otherwise the investment is not attractive.
2. Net Present Value – Discount the cash flows of both the costs and the benefits of the investment. The more positive the value, the more attractive the investment.
3. Discounted Payback Period – How long does it take for the investor to recover his investment. The shorter the payback, the more attractive the investment.
49
Simple Example of Discounting Module 5
Three Important Steps:
1. Identify the cash inflows (benefits) and cash outflows (costs) over the useful life of the investment
2. Identify your cost of capital
3. Discount the cash inflows and outflows using your cost of capital
i = 8% Year 1 Year 2 Year 3 Totals
Inflows $ 120,000 $ 84,000 $ 36,000 $ 240,000
Outflows $ (200,000) $ - 0 - $ - 0 - $ (200,000)
Difference $ (80,000) $ 84,000 $ 36,000 $ 40,000
Discount .9259 .8573 .7938
Present Value $ ( 74,072) $ 72,013 $ 28,576 $ 26,517
Net Present Value
50
Discounted Pay Back Period Module 5
A simple economic indicator – when will I recover all of my costs?
Net
Present Cumulative
Year Value Value
1 (74,072)$ (74,072)$
2 72,013$ (2,059)$
3 28,576$ 26,517$
You reach pay back in Year 3 for this investment
Per the Previous Slide
Example 3 – Evaluate Long Term Investment Module 5
51
Let’s walk through a complete example of evaluating a long term investment. The goal is to project out both the cost and benefits of the investment over its useful life. Once we know the cost and benefits, discount the amounts to reflect risk. A positive Net Present Value indicates that this investment adds value. A negative Net Present Value indicates that the investment destroys value within the business.
Module 6 Some Advanced Concepts
52
A few advanced concepts related to financial
management
Working Capital for Day to Day Operations Module 6
53
2016
Days in Receivables (per slide 25) 51
Days in Inventory (per slide 26) 59
Operating Cycle in Days 110
Less Accounts Payable (1) -33
Days to be Financed 77
(1) Days in Accounts Payables = 365 / Accts Payable Turnover
Accounts Payable Turnover = Total Purchases / Avg A/P Balance
A/R Held 1 Day (1/365 x Credit Sales for Year) 5,917$
Inv Held 1 Day (1/365 x Cost of Goods Sold for Yr) 22,575$
A/P Held 1 Day (1/365 x Purchases for Year) 3,150$
Most businesses cannot cover normal operating cycles. They must cover the short fall through high enough margins. In this example, if the company can turn the inventory over faster from 59 days to 55, this equates to $ 90,300 of more cash on hand for current operations ( 4 days x $ 22,575)
Working Capital represents the current funds to cover day to day operations and it comes from the excess of Current Assets over Current Liabilities
54
Ratio Model – Return on Investment Module 6
R O I
Capital Turnover
Profit Margin
Sales Invested Capital
Net Income
Long Term Assets
Working Capital
Revenues Expenses
How to drive higher returns on the total investment that has been made into the business – look at key drivers below:
55
Ratio Model – Sustainable Growth Module 6
56
Ratio Model – Financial Distress Module 6
Very predictive of financial distress and bankruptcy:
Inventory Analysis Module 6
57
Total Lead Time to produce, land, tag and place the apparel item is 12 days Throughout the year, the average units sold per day is 3 Absolute minimum inventory level = 12 x 3 = 36 units (reorder point) Add safety stock if inventory fluctuates @ 15% = 5 units + 36 units = 41 units
Six Months Sales in terms of Units Sold
Product Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17
Casual Pants 16 19 17 22 20 26
Bluejeans 35 38 46 41 42 44
Short Pants 12 8 9 11 7 8
Swim Trunks 6 8 4 4 5 3
Tee Shirts 75 92 112 107 137 128
ABC Inventory Segmentation
B B C C A
A = Spend most of your time trying to move this item, it generates your revenues B = Spend moderate time on this item C = Spend little time on this item, consider discontinuing
Calculate Inventory Reorder Level
57
Cost Reduction thru Process Improvement Module 6
58
Traditional approach to Cost Control – by General Ledger:
Better approach is to improve the Process!
General Ledger Account Balances
Year End Expense Accounts
Account Description Balance
4001 Cost of Goods Sold * 3,166,401.50
4003 Marketing & Promotion 377,560.00
4005 Salary Expense 474,906.82
4006 Payroll Tax Expense 86,089.15
4007 Equipment Maintenance 36,450.92
4009 Rent & Lease Expense 19,807.65
4011 Utilities Expense 11,050.86
4012 Insurance Expense 7,650.00
4014 Product Warranty Expense 6,672.00
4015 Depreciation Expense 22,880.00
4016 Interest Expense 26,404.20
4017 Tax Expense 101,678.89
Total Expenses 4,337,551.99
* consists of direct materials + direct labor + allocation of overhead
• Eliminate non-value added type activities (“Re” type activities)
• Compress hand-off’s in workflows
• Look for delays, wait times, waste, defects, holding inventory, etc.
• Too many manual processes – invest in technologies
• Look at how people spend their time – should be spent servicing an internal or external customer
Wrap Up
59
Summarize Key Points
60
1. Someone must keep the books – you must do accounting to understand if you are losing or making money.
2. Generate and review your financial statements on a monthly or quarterly basis
3. Analyze the financial statements with ratios, horizontal and vertical analysis – be analytical in how you look at numbers
4. Current Assets must turn over and go through cash 5. Long Term Assets must generate a Return greater than the cost to finance the
investment 6. Benchmark the financials to evaluate your financial performance according to
your industry (NAICS) code 7. Evaluate your long term investments – does it generate benefits greater than
the cost and if the life cycle is several years, consider discounting at the cost of financing or required return to see what the investment is worth to the business. This is what big companies do when they make major investment decisions.
61
Matt H. Evans [email protected] DC SCORE Office: 409 3rd Street, SW Suite 100 A Washington D.C. 20024 Phone: 202-619-1000