Chapter 12-Financial Management

12-1 Financial Planning FINANCIAL PLANNING Beginning a Business The moment a decision is made to start a business, financial planning begins.

The following questions need to be answered: How much money will be needed to start the business? Were will that financing come from? How will adequate funds be obtained to operate the business for the months or years until it becomes successful?

What will be the best sources of sales and other income? What will be the major expenses? When must they be paid? Many new businesses fail due to poor financial planning.

Ongoing Operations Finances are a key part of the operations of all businesses. Every business activity cost money. Without careful planning and management, those costs can grow to a level where the business income cannot cover expenses.

Revenue- all income a business receives over a period of time Expenses- the costs of operating a business

Every business is guided by the basic financial equation: Revenue – Expenses = Profit or Loss If revenue is greater than expenses, the business will make a profit. If expenses are greater than revenue, the business will suffer a loss.

The profitability of a business is directly linked to the number of employees and the wages the business can pay. Managers and employees should find ways to reduce waste and control expenses. They can also make suggestions about ways to increase sales and income through better products and services.

Business Expansion Successful businesses expand to be able to serve more customers, reach unserved markets, and sell new product. Expansion costs money The income generated by the expansion will be far greater than the cost.

Business expansion calls for research to develop new products and locate new markets. New factories and equipment may be needed to produce the products. Additional employees must be hired and trained.

Most expansion plans occur over a long period of time and cost thousands or even millions of dollars. Planning must anticipate the: cost associated with the expansion source of the funds to pay for the expansion expected income that will result from the new plans If the planning is not correct, the expansion results in heavy losses rather than profits or the business may fail.

Checkpoint>> What is the basic financial equation for businesses?

DEVELOPING BUSINESS BUDGETS Budget- provides detailed plans for the financial needs of individuals, families, and businesses. A business budget has two main purposes: Anticipate sources and amounts of income. Predict the types and amounts of expenses for a specific business activity of the entire business.

The business must be able to identify and predict the amount of each source of income and each type of expense. Determine when each expense must be paid and when income will be received. For a business to succeed, enough revenue must be available to pay all expenses

Sources of Budget Information The main source of information for an existing business are the financial records. Budgeting for new businesses is much harder for a new business. No financial records exist to serve as a guide.

Other sources of information must be used including: Small Business Administration- provides many planning tools for new businesses Guides to developing a budget Financial information to help predict income and expenses

Private businesses that collect and publish financial information on similar businesses and industries Examples: Fortune, Forbes, Entrepreneur, and The Wall Street Journal

A new franchisee will typically receive assistance from the franchisor. This help might include a complete beginning budget. A bank or other financial institution where a new business has established accounts is another source for financial planning.

Budget Preparation The most important step in financial planning is developing a budget. Compare the use of a budget to a road map when traveling to an unknown location. Without the map, you would have little idea of where you are going while you travel. If you take a wrong turn, you have difficulty knowing your mistake. It will be hard to get back to the correct road without the map.

A budget identifies where the business is going. Allows the owner to determine if the business is making progress toward its financial destination. By regularly comparing the business’ financial performance to the budget, the owner can determine if the budget goals are being met. If not, the owner can make corrections before serious financial problems occur.

The budgeting process includes four fundamental steps: Prepare a list of each type of income and expense that will be part of the budget. Gather accurate information from business records and other information sources for each type of income and expense. Create a budget by calculating each type of income, expense, and the amount of net income or loss. Explain the budget to people who need financial information to make decisions.

The person responsible for preparing budgets needs several skills: Understanding of financial information Computer skills Mathematical abilities Communication skills

New small business owners usually get help from an accountant or banker when preparing the first budget. Small and medium –sized businesses hire an accounting firm to maintain financial records and help with budgeting. Larger businesses employ accountants and other financial planning experts to maintain the business’ financial records.

Checkpoint>> Why are the four steps in preparing a budget important for each business owner to follow?

TYPES OF BUDGETS Start-Up Budget Start-up budget- plans income and expenses from the beginning of a new business or a major business expansion until it becomes profitable

Most start-ups require expenditures (expenses) of thousands or even hundreds of thousands in order to open. Buildings and equipment must be purchased or leased. New employees will be hired or existing employees retrained. Expenses for utilities, licenses, advertising, and transportation.

Operating Budget Operating budget- describes the financial plan for ongoing operations of the business for a specific period Usually planned for three months, six months, or one year Prepared for the entire business Income and expenses from prior budgets are reviewed Planners look for changes that could increase or decrease income and expenses. Finally the new budget is created.

Cash Budget Cash budget- an estimate of the actual money received and paid out for a specific period Anticipates the amount of cash that will come into a business and the cash that will be paid out during each week or month of operation. If a new business is losing money, it still must have adequate cash on hand to pay current expenses. Even profitable businesses may have times when adequate cash in not available due to high expenses or a delay in receiving payments.

Checkpoint>> Why do you think businesses need to prepare each of the three types of budgets described above?

Please complete the 12-1 Assessment Questions found at the end of the packet.