Financial Statements and Financial Management

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SMALL BUSINESS MANAGEMENT

Financial Management and Financial Financial Management and Financial StatementsStatements

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The Need for Financial Records

Uses of Accounting InformationUses of Accounting Information

– EntrepreneursEntrepreneurs To plan and controlTo plan and control To motivate employeesTo motivate employees

– InvestorsInvestors To evaluate performanceTo evaluate performance

– LendersLenders To evaluate creditworthinessTo evaluate creditworthiness

– GovernmentGovernment To verify taxes owedTo verify taxes owed To approve new stock issuesTo approve new stock issues

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The Accounting Cycle

Recording TransactionsRecording Transactions Classifying Transaction TotalsClassifying Transaction Totals Summarizing DataSummarizing Data

– Balance Sheet (Statement of Financial Position)Balance Sheet (Statement of Financial Position)– Income Statement (Statement of Profit and Income Statement (Statement of Profit and

Loss)Loss)– Cash Flow Statement and/or Changes in Cash Flow Statement and/or Changes in

Financial PositionFinancial Position

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Accounting Systems for Small Business

One-Book SystemOne-Book System One-Write SystemOne-Write System Multi-journal SystemMulti-journal System Outsourcing Financial ActivitiesOutsourcing Financial Activities

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Accounting Systems for Small Business

Small Business Computer SystemsSmall Business Computer Systems DisadvantagesDisadvantages

– CostCost– ObsolescenceObsolescence– Employee ResistanceEmployee Resistance– CapabilitiesCapabilities– Setup TimeSetup Time– Failure to Compensate for Poor BookkeepingFailure to Compensate for Poor Bookkeeping

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Management of Financial Information for Planning

Short Term Financial PlanningShort Term Financial Planning

– Clarification of ObjectivesClarification of Objectives

– CoordinationCoordination

– Evaluation and ControlEvaluation and Control

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Long Term Financial PlanningLong Term Financial Planning– The Capital Investment DecisionThe Capital Investment Decision

rate of return methodrate of return method present value methodpresent value method payback methodpayback method

– The Capacity DecisionThe Capacity Decision break even pointbreak even point

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Long Term Financial Planning (cont.)Long Term Financial Planning (cont.)– The Expansion DecisionThe Expansion Decision

Effect of fixed cost adjustmentsEffect of fixed cost adjustments Effect of variable cost adjustmentsEffect of variable cost adjustments

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Evaluation of Financial Performance

Management of Current Financial PositionManagement of Current Financial Position– length of time for paymentslength of time for payments– three essential componentsthree essential components

time taken to pay accounts payabletime taken to pay accounts payable time taken to sell inventorytime taken to sell inventory time taken to receive payment for inventorytime taken to receive payment for inventory

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Evaluation of Financial StatementsEvaluation of Financial Statements Ratio AnalysisRatio Analysis

– Liquidity ratiosLiquidity ratios current ratio = current assets / current liabilitiescurrent ratio = current assets / current liabilities

– over 1:1, usually between 1:1 and 2:1over 1:1, usually between 1:1 and 2:1

Acid test/ Quick ratio = current assets-inventories/ Acid test/ Quick ratio = current assets-inventories/ current liabilitiescurrent liabilities

– 1:1 is considered healthy1:1 is considered healthy

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– Productivity ratiosProductivity ratios Inventory turnover = COGS / Average inventory at Inventory turnover = COGS / Average inventory at

average costaverage cost Inventory turnover = Sales / Average inventory at Inventory turnover = Sales / Average inventory at

retail priceretail price Collection period = Accounts receivable / Daily Collection period = Accounts receivable / Daily

credit salescredit sales

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– Profitability ratiosProfitability ratios Gross margin = sales - COGSGross margin = sales - COGS Profit on sales = net profit before tax / sales Profit on sales = net profit before tax / sales Expense ratio = Expense item / SalesExpense ratio = Expense item / Sales Return on Investment = Net profit before tax / Return on Investment = Net profit before tax /

owner’s equityowner’s equity

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– Debt ratioDebt ratio Total debt to equity = Total debt / owner’s equityTotal debt to equity = Total debt / owner’s equity

– not greater than 4:1not greater than 4:1

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Credit and the Small Business

Advantages of Credit UseAdvantages of Credit Use– will undoubtedly increase saleswill undoubtedly increase sales– necessary to remain competitivenecessary to remain competitive– credit customers exhibit more store loyaltycredit customers exhibit more store loyalty– credit customers are more concerned with credit customers are more concerned with

quality of service vs. pricequality of service vs. price– credit records can be used for future planningcredit records can be used for future planning

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Disadvantages of Credit UseDisadvantages of Credit Use– will be some bad debts - depends on credit will be some bad debts - depends on credit

policy and monitoringpolicy and monitoring– slow payers cause lost interest and capitalslow payers cause lost interest and capital– increases bookkeeping, mailing and collection increases bookkeeping, mailing and collection

expensesexpenses

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Management of a Credit ProgramManagement of a Credit Program– Determine Administrative PoliciesDetermine Administrative Policies– Set Criteria for Granting CreditSet Criteria for Granting Credit– Set up a System to Monitor AccountsSet up a System to Monitor Accounts– Establish a Procedure for CollectionEstablish a Procedure for Collection

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Use of Bank Credit CardsUse of Bank Credit Cards

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Concept Checks

1. Describe the three steps in the accounting 1. Describe the three steps in the accounting

cycle.cycle.

2. What are the three financial statements , as 2. What are the three financial statements , as

discussed in the text, that are valuable to a discussed in the text, that are valuable to a

small business owner?small business owner?

3. List the bookkeeping systems used by a 3. List the bookkeeping systems used by a

small business. small business.

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Concept Checks 4. What are some of the capabilities of 4. What are some of the capabilities of

computers which can benefit small computers which can benefit small business?business?

5. What are some possible disadvantages of 5. What are some possible disadvantages of computer ownership?computer ownership?

6. In the short term, why is budgeting a 6. In the short term, why is budgeting a valuable tool? valuable tool?

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Concept Checks

7. What are the three types of long-term 7. What are the three types of long-term financial planning decisions that could financial planning decisions that could affect the business?affect the business?

8. What measure can be used to evaluate the 8. What measure can be used to evaluate the results which are found in the financial results which are found in the financial statements?statements?

9. What is the business cycle of a small 9. What is the business cycle of a small business? Why is it important? business? Why is it important?

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Concept Checks

10. Why is ratio analysis important?10. Why is ratio analysis important?

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Appendices

A. Checklist for buying a small business A. Checklist for buying a small business computercomputer

B. Use of Financial Ratios for a Small B. Use of Financial Ratios for a Small Business (Car Dealer)Business (Car Dealer)

Documents

Financial Statements and Financial Management