Essential Standard 4.00 Understanding the role of finance in business. 1

Objective 4.01 Understand financial management. 2

Topics Financial planning Financial planning Business budgets Business budgets Financial records and statements Financial records and statements Financial performance ratios Financial performance ratios 3

Financial planning 4

Financial Planning Why should a business do financial planning? Reduces financial uncertainties Reduces financial uncertainties Increases control of financial activities Increases control of financial activities Provides a ‘map of finances’ for business Provides a ‘map of finances’ for business Makes it easier to ‘stick’ to financial processes and goals. Makes it easier to ‘stick’ to financial processes and goals. 5

Financial Planning continued Phases of business Start-up Start-up Financial planning includes determining the amount of money needed to start and operate the business until a profit is made. Also the major categories of sales and expenses are determined. Financial planning includes determining the amount of money needed to start and operate the business until a profit is made. Also the major categories of sales and expenses are determined. Operation Operation Financial planning includes determining whether they are making enough money to operate. The basic formula used is Revenue – Expenses = Profit or Loss. Financial planning includes determining whether they are making enough money to operate. The basic formula used is Revenue – Expenses = Profit or Loss. Expansion Expansion Financial planning includes determining whether enough money is made to cover growth opportunities. Financial planning includes determining whether enough money is made to cover growth opportunities. 6

Business budgets 7

Business Budgets Types of business budgets: Start-up budget used by a new business or during expansion of a business until profits are made. Start-up budget used by a new business or during expansion of a business until profits are made. Operating budget used for ongoing business operations for a specific period. Operating budget used for ongoing business operations for a specific period. Cash budget used to estimate cash flow in and out of a business. Cash budget used to estimate cash flow in and out of a business. 8

Business Budgets continued Steps for preparing a business budget: Prepare a list of income and expense items. Prepare a list of income and expense items. Gather accurate information from business records. Gather accurate information from business records. Create the budget. Create the budget. Clearly communicate the budget to key employees in order to make sound business decisions. Clearly communicate the budget to key employees in order to make sound business decisions. 9

Financial records and statements 10

Financial Records and Statements What is the purpose of financial records? What is the purpose of financial records? Financial records provide specific information about business activities that is used to analyze the financial performance of a business. Financial records provide specific information about business activities that is used to analyze the financial performance of a business. 11

Financial Records and Statements Financial records used by businesses: Financial records used by businesses: Asset records- Things that have value Asset records- Things that have value Depreciation records- How assets lose value over time. Depreciation records- How assets lose value over time. Inventory records- The goods you have to sell. Inventory records- The goods you have to sell. Records of accounts- Records of accounts- Accounts payable- bills you owe Accounts payable- bills you owe Accounts receivable- Businesses who owe you money Accounts receivable- Businesses who owe you money

Financial Records and Statements Cash records- Cash in/out of the business Cash records- Cash in/out of the business Payroll records- Employee pay Payroll records- Employee pay Tax records- Taxes the business owes the state and federal government Tax records- Taxes the business owes the state and federal government

Financial Records and Statements What are financial statements? What are financial statements? Financial statements provide a picture of the financial performance of a business. Financial statements provide a picture of the financial performance of a business. What are the main financial statements: What are the main financial statements: Balance Sheet Balance Sheet Income Statement Income Statement 14

Financial Records and Statements Balance Sheet Balance Sheet Assets=Liabilities +Owner’s Equity Assets=Liabilities +Owner’s Equity Assets: Things that have value Assets: Things that have value What are some examples???? What are some examples???? Liabilities: Things you owe Liabilities: Things you owe What are some examples What are some examples Owner’s Equity: Assets – Liabilities Owner’s Equity: Assets – Liabilities This is what a business is worth. This is what a business is worth.

Financial Records and Statements Income Statement Income Statement The Income Statement has three sections: The Income Statement has three sections: Revenue Revenue Sales Sales Interest Income Interest Income Expenses Expenses Rent Rent Salaries Salaries Net Profit / Loss Net Profit / Loss Net Profit: Sales are greater than expenses Net Profit: Sales are greater than expenses Net Loss: Expenses are greater than sales Net Loss: Expenses are greater than sales

Financial Records and Statements What is the difference between a balance sheet and an income statement? What is the difference between a balance sheet and an income statement? A balance sheet includes assets, liabilities, and owner’s equity. A balance sheet includes assets, liabilities, and owner’s equity. An income statement includes sales, expenses, and net profit or loss. An income statement includes sales, expenses, and net profit or loss.

Cash Flow Statement (CFS) Complements the balance sheet and income statement Complements the balance sheet and income statementbalance sheetincome statementbalance sheetincome statement A mandatory part of a company's financial reports since 1987 A mandatory part of a company's financial reports since 1987 Records the amounts of cash and cash equivalents entering and leaving a company. Records the amounts of cash and cash equivalents entering and leaving a company.cash The CFS allows investors to understand The CFS allows investors to understand How a company's operations are running How a company's operations are running Where its money is coming from Where its money is coming from How it is being spent. How it is being spent.

Financial performance ratios 19

Financial Performance Ratios Financial performance ratios are comparisons using a company’s financial data to determine how well a business is performing. Financial performance ratios are comparisons using a company’s financial data to determine how well a business is performing. The four main types of financial ratios: The four main types of financial ratios: Current ratio Current ratio Debt to equity ratio Debt to equity ratio Return on equity ratio Return on equity ratio Net income ratio Net income ratio 20

Financial Performance Ratios continued Current ratio Current ratio Equals current assets/current liabilities Equals current assets/current liabilities Represents assets that the business could convert into cash in < 1 year compared to liabilities that it must pay in < 1 year; shows ability of company to pay debts as they become due. Ideally, this ratio should be over 1.0. Represents assets that the business could convert into cash in < 1 year compared to liabilities that it must pay in < 1 year; shows ability of company to pay debts as they become due. Ideally, this ratio should be over 1.0. Normally, the higher the ratio, the more favorable it is for the company. Normally, the higher the ratio, the more favorable it is for the company. 21

Financial Performance Ratios continued Debt to equity ratio Debt to equity ratio Equals total liabilities/owner’s equity Equals total liabilities/owner’s equity Shows how much the business relies on money borrowed externally versus money from within the business. Ideally, this ratio should be less than 2.0. Shows how much the business relies on money borrowed externally versus money from within the business. Ideally, this ratio should be less than 2.0. Normally, the lower this ratio, the more favorable it is for the company. Normally, the lower this ratio, the more favorable it is for the company. 22

Financial Performance Ratios continued Return on equity ratio Return on equity ratio Equals net profit/owner’s equity Equals net profit/owner’s equity Indicates the rate of return the owners/stockholders are receiving on their investments. There is not an ideal ratio; however, it is used to compare with other types of investments to see if there may be another investment that is more desirable. Indicates the rate of return the owners/stockholders are receiving on their investments. There is not an ideal ratio; however, it is used to compare with other types of investments to see if there may be another investment that is more desirable. Normally, the higher the ratio, the more favorable it is for the company. Normally, the higher the ratio, the more favorable it is for the company. 23

Financial Performance Ratios continued Net income ratio Net income ratio Equals total sales/net income Equals total sales/net income Shows the amount of sales needed for each dollar of net income. While there is not an ideal ratio, managers use this number to compare to past periods to determine how changes in sales affect net income. Shows the amount of sales needed for each dollar of net income. While there is not an ideal ratio, managers use this number to compare to past periods to determine how changes in sales affect net income. Normally, the lower the ratio, the more favorable it is for the company, as it takes less in sales to generate net income. Normally, the lower the ratio, the more favorable it is for the company, as it takes less in sales to generate net income. 24