Financial Aspects of a Business Plan Chapter 36.2

Estimating Business Income and Expenses The income statement is a summary of your business’s income and expenses during a specific period, such as a month, a quarter, or a year. Also called a profit and loss statement.

Income Statement Several Main parts: Total and Net sales Cost of goods sold Gross Profit Expenses of operating the business Net income from operations Net profit before income taxes Net profit after income taxes

Estimating Total Sales The income generated by a business depends on the yearly volume of sales. Verify your estimated sales volume by comparing it with projected industry figures for your size of business and location. The accuracy of your sales estimates will also depend on the quality of your market analysis.

Calculating Net Sales The total of all sales for any period of time is called gross sales. The total of all sales returns and allowances is subtracted from gross sales to get net sales. Net sales represent the amount left after gross sales have been adjusted for returns and allowances.

Cost of Goods Sold The total amount spent to produce or to purchase the goods that are sold is called the cost of goods sold. To calculate cost of goods sold, use the following formula: Beginning Inventory + Net Purchases Ending Inventory = Cost of Goods Sold

Determining Gross Profit Gross profit on sales is the difference between the net sales and the cost of goods sold. The formula for calculating gross profit: Net Sales - Cost of Goods Sold = Gross Profit

Projecting Business Expenses Operating Expenses are the costs of operating the business, which includes both variable and fixed expenses. Variable expenses Change from one month to the next. Include items such as advertising, office supplies, telephone and utilities. Calculated as a percentage of some baseline amount.

Projecting Business Expenses Fixed Expenses Costs that remain the same for a period of time. Include items such as depreciation, insurance, rent and office salaries. Depreciation: represents the amount by which the value of a business’s assets has fallen in a given period of time.

Calculating Payroll Expenses The amount earned by an employee is gross pay. Net pay is what the employee receives after deductions for taxes, insurance, and voluntary deductions.

Net Income from Operations Net income is the amount left after the total expenses are subtracted from gross profit. A net loss results when total expenses are larger than the gross profit on sales. Interest is the money paid for the use of money borrowed or invested. The principal is the interest paid on any money you borrow to start your business.

Net Profit or Loss before taxes Net Income from operations + Other Income - Other Expenses = Net profit (or loss) before taxes

Net Profit or Loss after Taxes The amount left over after federal, state, and local taxes are subtracted. Represents the actual profit from operating the business for a certain period of time. The projected income statement should be completed on a monthly basis for new businesses. Then completed on a quarterly basis after the first year.

Balance Sheet The balance sheet is a summary of a business’ assets, liabilities and owner’s equity. Current assets are expected to be converted to cash in the upcoming year. Examples include cash in the bank, accounts receivable, and inventory.

Balance Sheet Fixed assets are used over period of years to operate your business. Examples include land, buildings, equipment, furniture, and fixtures. Current Liabilities are the debts the business expects to pay off during the upcoming business year Examples include accounts payable, notes payable, taxes payable, and salaries.

Balance Sheet Long-term liabilities are debts that are not due in the next 12 months. Examples include mortgages and long term loans.

Analysis of Financial Statements Lenders use the following types of operating ratios to determine how well a business is operating over a certain period of time: Liquidity ratios: used to analyze the ability of a firm to meet its current debts. Current assets divided by current liabilities. The higher the ratio the better.

Analysis of Financial Statements The Acid Test Ratio: used to see if the company can meet its short-term cash needs. Formula is cash plus marketable securities plus net receivables divided by current liablities. Activity Ratios: used to determine how quickly assets can be turned into cash. Divide net sales by average trade receivables. The lower the ratio the better.

Stock Turnover Ratio: measures how many days it takes to turn the inventory. Formula: Divide net sales by average trade receivables. Profitability Ratios measure how well the company has operated in the past year. Profit Margin on Sales (net income/net sales) Rate of Return on Assets (net income/total assets.

Cash Flow Statement A monthly plan that shows when you anticipate cash coming into the business and when you expect to pay out cash. Itemizes how much cash you started with, projected cash expenditures, and how and when you plan to receive cash. Tells when you will need additional funds and when you will have cash left over.

Loans You should be able to borrow additional money if needed if your business has potential and your balance sheet shows enough assets to serve as collateral.