MGT601 SME MANAGEMENT

Lesson 24 Aspects of Financial Management

Chapter Learning Objectives This lecture deals with;  Concept of Financial Management/Managerial Finance  Aspects of Financial Management  Breaking-even Point  Break-even Point formula

Financial Management FM can be defined as:  The management of the finances of a business / organisation in order to achieve financial objectives.  Managerial finance is the branch of finance that concerns itself with the managerial significance of finance techniques. It is focused on assessment rather than technique.

Financial Management…. The key objectives of financial management would be to:  Create wealth for the business  Generate cash, and  Provide an adequate return on investment bearing in mind the risks that the business is taking and the resources invested.

Aspects of Financial Management 1. Winning the Cash Flow War. 2. Understanding the Nature of Profit. 3. Breaking Even. 4. Working Capital Management.

1. Winning the Cash Flow War  One of the common characteristic that new and small businesses have in common is a tendency to change their size and shape quickly.  In early weeks and months customers are few and each customer mean a large percentage increase in sales.

Continued…..  A large increase in sales in turn means an increase in raw material and perhaps more wages and other expenses.  Generally these expenses are to be met before your customer pays up. But until the money comes in, the business has to find cash to meet its bills.

Continued…. The measures will help you to minimize the need for extra cash to finance the sales growth.  Send Bills Out Promptly Have a list of debtors, who owe money must be chased up for payment. It is good idea to list the debtors by age of debt as this shows who owes how much and for how long. Take non-nonsense approach with them and stop suppliers to people who take too long to pay or threaten to sue.

Continued…  Check Credit Ratings Before taking on a new or big customer have them checked out. If they are blue-chip you may be able to factor the debt and get up 80% of the cash owed immediately. Alternatively, offer discount for cash and charge interest on over due amount.

Continued….  Keep Stock Levels Down The chances are that the opening stock will be out of line with customer demand. After all, before the start companies have to guess what will sell. Once a pattern develops to emerge, order accordingly. Too many new ventures spend all their cash on opening stock.

Continued…  Take Credit As rule of thumb successful business men and women try to take as much credit as they are giving. So if their customers take a month to pay, they aim to take a month’s credit from their suppliers.

2. Understanding the Nature of Profit  A significant number of small business firms operate largely on a cash basis.  That is, most of their transactions and income come in either as cheques or in folding notes.

Continued…  The whole problem arises from the difference between accounting definition of Profit and common- sense definition of cash.  Cash and profits are not same thing, even in cash business, and a business need both cash and profits to survive.

Continued… The fundamental difference between cash and profits can best be explained under the following heading.  The Realization Concept  Cost of Sale  Matching Expenses

a. The Realization Concept In accounting, income is usually recognized as having been earned when the goods (or services) are dispatched and the invoice sent out, not when an order is receive, or on assumption of firm order, or expectation of prompt payment.

b. Cost of Sale Obviously the goods which have not yet been dispatched must still be held in stock. A vital calculation is that of how much stock has been used up over the period. This is calculated by adding the opening stock to any purchase you have made and taking away the stock that is left to get it right. Stock used over a period = Opening stock + purchases – Ending Stock.

Continued… The materials used in business are usually a major element of expense and as such are separated from the rest of expenses. For a manufacturing company materials are easy to define. For service business the sum is less obvious, but still necessary.

c. Matching Expenses Expense is a general name given to the cost incurred in selling marketing, administrating, distributing and advertising a company’s products or services. Some of these expenses may be for items not yet paid for. The profit and loss account sets out to “match” income and expenditure to the period in which they were incurred.

Breaking-even  A technique for which identifying the point where the total revenue is just sufficient to cover the total cost. The formula for break even point is fixed costs/fixed expense over contribution per unit.  The break-even point (BEP) is the point at which cost or expenses and revenue are equal: there is no net loss or gain,

Continued…  Fixed cost is a cost which remains fix in total but varies per unit of sales, e.g. rent of the shop or salaries of employees.  Variable cost is a cost varies in total but remains fixed per unit of sales, e.g. direct material, direct labour.

Continued… Here is an example; if rent is $10,000.The angled line running from the top of the fixed costs line is the variable cost. In this example we plan to buy at $3 per unit. so every unit we sell adds that much to our assets. Only one element is needed to be calculated is breakeven point. We plan to sell it out at $5 per unit. So this line is calculated by multiplying the units sold by that price.

Break-even Point formula  Fixed Costs = Selling Price–Unit Variable Cost  Breakeven Point = Fixed Costs / (Selling Price–Unit Variable Cost)  Breakeven Point = 10,000 / (5-3) = 5,000 units

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