Financial Statements Business Management

Today’s Objectives Interpret basic financial statements, including cash flow, income statement, and a balance sheet. Prepare a budget to include short- term and long-term expenditures.

Essential Questions What is the purpose of each financial statement: income statement, cash flow, and balance sheet? Which figures are included on each financial statement? Explain the significance of the break- even point as it relates to finances. What is the financial equation and how does it relate to the balance sheet?

Financial Statements Income Statement Cash Flow Statement Balance Sheet

The Income Statement Prepared at the end of each month Tracks income and expenses Also called a profit and loss statement Purpose of an Income Statement

Preparing the Income Statement Sales – how much money the company will be receiving for selling a product Total Cost of Goods Sold – the cost of making one unit multiplied by the number of units sold Gross Profit = sales – cost of goods sold Operating Costs – items that must be paid to operate a business including fixed costs and variable costs (USAIIR) Figures Included on an Income Statement

Preparing the Income Statement Profit Before Taxes – profit before taxes but after ALL other costs have been paid Taxes – payments required by federal, state, and local governments based on a business’s profit (sales tax, income tax) Net Profit or Net Loss – a business’s profit or loss after taxes are paid Figures Included on an Income Statement

Example of an Income Statement The Math Sales $100 (25 ties × $4 per tie = $100) less Total Cost of Goods Sold $50 (25 ties × $2 per tie = $50) Gross Profit ($100 - $50 = $50) less Operating Costs Fixed Costs $24 ($24 for flyers) Variable Costs $0 Profit Before Taxes $26 ($50 - $24 = $26) Taxes $6 Net Profit $20 ($26 - $6 = $20)

Depreciation If you buy expensive, long-lasting assets, you will want to include depreciation in your income statement (fixed cost). Depreciation is when a certain portion of the cost of an asset is subtracted each year until the asset’s value reaches zero. Reflect wear & tear

Calculating Depreciation Hometown Restaurant buys $3,000 worth of tables and chairs that will last approximately 5 years before needing to be replaced. The income statement shows that $600 is subtracted each year to “save” for the new tables & chairs to be purchased in the future.

Financial Ratio Analysis Entrepreneurs don’t just look at their income statements… they analyze them by dividing sales into each line item. Each item can then be expressed as a percentage of sales. Relating each piece of the income statement to sales will help you notice changes in costs from month to month. Figures Included on an Income Statement

Income Statement for Lola’s Custom Draperies, Inc. March 1999 Sales $85,456 100% Cost of Goods Sold Materials Labor 11,550 17,810 less Total Cost of Goods Sold $29,360 ($11,550 + $17,810) 34% Gross Profit $56,096 ($85,456 - $29,360) 65.6% Operating Costs Fixed Costs Factory Rent & Utilities Salaries & Admin Depreciation Variable Costs Sales Commissions $ 8,000 12,000 2,000 8,000 less Total Operating Costs $30,000 ($8,000 + 12,000 + 2,000 + 8,000) 35% Profit Before Taxes $26,096 ($56,096 - $28,000) 30% Taxes (25%) 6,524 ($26,096 x 0.25) 7.6% Net Profit / Loss $19,572 ($26,096 - $6,524) 22.9%

Income Statement for a Fast-Food Restaurant Example Income Statement for a Fast-Food Restaurant Sales $2,600,000 100% Cost of Goods Sold Food Paper Products $792,000 108,000 less Total Cost of Goods Sold $900,000 35% Gross Profit $1,700,000 65% less Total Operating Costs $1,000,000 38% Profit $700,000 27% Taxes (33%) $233,000 9% Net Profit $467,000 18%

Summarizing the Income Statement Purpose track monthly income & expenses Includes total of seven (7) figures plus ratios Also accounts for depreciation, which is an estimated or projected figure

The Break-Even Analysis When sales and costs are equal, the total at the bottom of the income statement is zero. This condition is called the break- even point. Many new businesses lose money in the beginning, but a business must at least break even to survive. Businesses must know how many units to sell during a month to cover costs and break even. Significance of Break-Even point

Determining the Break-Even Point Define your unit of sale. Figure your gross profit per unit. [ Selling Price per Unit – Cost of Goods Sold per Unit = Gross Profit per Unit ] Calculate break-even units. Typically calculated assuming all operating costs are fixed. [ Monthly Fixed Costs ÷ Gross Profit per Unit = Break-Even Units ] Significance of Break Even Point

The Cash Flow Statement Records inflows and outflows of cash when they actually occur Takes out sales on credit and depreciation so that business owners can see how much money actually flowed in/out in a month All sources of cash that come into the business with actual dates they are received (receipts) Cash outflows that must be made within the month (disbursements) Net change in cash flow before and after taxes Purpose of & Figures Included on a Cash Flow Statement

The Balance Sheet Prepared at the end of the business’s fiscal year Usually October 1 to September 30 Based on the Financial Equation Assets – all items of worth owned by the business Liabilities – all debts owed by the business Owner’s Equity – also called capital or net worth; amount left over after liabilities are subtracted from assets Purpose of & Figures Included on a Balance Sheet

The Financial Equation Assets – Liabilities = Owner’s Equity

Example of a Balance Sheet Hometown Restaurant – Balance Sheet, January 1999 Assets Liabilities Cash $10,000 Loan (for stove) $5,000 Tables & Chairs 3,000 Owner’s Equity 11,900 Stove 5,000 ($10,000 cash + 3,000 tables & chairs - $1,100 depreciation) Subtotal $18,000 less Depreciation 1,100 Total Assets $16,900 Total Liabilities

Closing Task Describe an income statement – what is its purpose and what is included? Describe a cash flow statement – what is its purpose and what is included? Describe the balance sheet – what is its purpose and what is included? Write the financial equation. How does it relate to the balance sheet? Why should business owners complete a Break-Even Analysis?

Understanding a Balance Sheet Activity

Understanding a Balance Sheet Activity Assets Cash Accts Rec. – Dean Mills Supplies Insurance Liabilities Accts Pay. – Topline Owner’s Equity Owner’s Capital Expense? Investment? Revenue? Withdrawal?