Chapter 3 Financial Management Part 2 BCN 4772 Summer 2007

Financial Management What are the two main reasons businesses fail? What are the two main reasons businesses fail? Lack of a good Idea Lack of a good Idea Under Capitalization Under Capitalization Capitalization Capitalization Start-up Capital Start-up Capital Working Capital Working Capital Expansion Capital Expansion Capital

Financial Management Start-up Capital Start-up Capital Rents and deposits Rents and deposits Starting Inventory Starting Inventory Salaries Salaries Advertising Advertising Equipping and making repairs Equipping and making repairs Organizing Costs Organizing Costs Insurance Premiums Insurance Premiums Taxes and Licenses Taxes and Licenses Attorney and accounting fees Attorney and accounting fees Management, consultant and counseling fees Management, consultant and counseling fees Utilities Utilities Garbage removal Garbage removal

Financial Management Sources of Start-up Capital Sources of Start-up Capital Personal Savings Personal Savings Borrow from friends, banks, other Borrow from friends, banks, other Borrow from life insurance policies Borrow from life insurance policies Mortgage residential real estate Mortgage residential real estate Sell stock Sell stock Venture Capital from public or private sources Venture Capital from public or private sources

Financial Management Working Capital Working Capital Cost of doing business Cost of doing business Direct costs Direct costs Indirect costs Indirect costs Short term Short term Long term Long term Seasonal Seasonal Equipment costs Equipment costs Applicable start-up costs Applicable start-up costs

Financial Management Sources of Working Capital Sources of Working Capital Some of the same sources for Start-up capital Some of the same sources for Start-up capital Mortgage Commercial or industrial real estate Mortgage Commercial or industrial real estate Good money management Good money management Trade credit from suppliers Trade credit from suppliers Finance A/R’s Finance A/R’s Factor AR’s Factor AR’s

Financial Management Expansion Capital Expansion Capital Requires a great deal of capital Requires a great deal of capital Easier to identify? Easier to identify? Needed to purchase new equipment Needed to purchase new equipment New Building New Building Finance a large project Finance a large project May require sustained business period 2-5 yrs May require sustained business period 2-5 yrs

Financial Management Sources of Expansion Capital Sources of Expansion Capital Same as Start-up and Working Capital Same as Start-up and Working Capital Equipment leaseback option Equipment leaseback option Borrow from government Borrow from government Bond Bond Community economic development program Community economic development program

Financial Management Debt Restructuring Debt Restructuring 4th type of capital need 4th type of capital need Need if business is failing Need if business is failing Seek professional accounting and legal services Seek professional accounting and legal services

Financial Management Sources for Capital Sources for Capital Bank Loans Bank Loans Common Stock Common Stock Debentures Debentures Notes Payable Notes Payable Mortgages Payable Mortgages Payable Capital Leasing Capital Leasing

Financial Management Bank Financing Bank Financing How much? How much? Is it enough? Is it enough? How long? How long? When and how to repay loan? When and how to repay loan? Is the debt secured? Is the debt secured? What is the opportunity cost? What is the opportunity cost? Is there a better way to get the money? Is there a better way to get the money?

Financial Management Bank Financing Terminology Bank Financing Terminology Principal Principal Term Term Rate Rate Maturity Value Maturity Value Single Payment Loan Single Payment Loan Ordinary Interest Ordinary Interest Compounded Interest Compounded Interest Discount Discount Installment Loan Installment Loan

Financial Management Common stock Common stock Preferred Stock Preferred Stock Par Value Par Value No Par Value Stock No Par Value Stock Additional Paid in Capital Additional Paid in Capital Convertible Preferred Stock Convertible Preferred Stock Cumulative Preferred Stock Cumulative Preferred Stock Class B Common Stock Mortgage Payable Note Payable Debentures Convertible Debentures Letter of credit Capital Lease Corporate Financing

Financial Management Record keeping and creating Record keeping and creating Estimating Records Estimating Records Job Cost Records Job Cost Records Change Order Records Change Order Records Equipment Records Equipment Records Contracts Contracts Accounting Records Accounting Records

Financial Management Estimating Records Estimating Records Direct and Indirect Job Costs Direct and Indirect Job Costs Amounts of Material Needed Amounts of Material Needed Man-power Needed Man-power Needed Estimating process Estimating process Determine labor, material and equipment needs Determine labor, material and equipment needs How much subcontracting? How much subcontracting? Assign prices to quantities Assign prices to quantities Add in: indirect costs, overhead and profit Add in: indirect costs, overhead and profit

Financial Management Job Cost Records Job Cost Records Must account for several jobs at same time Must account for several jobs at same time Each contract is treated as separate company Each contract is treated as separate company Bad record keeping leads to company failure Bad record keeping leads to company failure Include all costs Include all costs Also should contain data from original estimate Also should contain data from original estimate

Financial Management Change orders Change orders Contract modification Contract modification Agreement between owner and contractor Agreement between owner and contractor Initiated by either owner or contractor Initiated by either owner or contractor Must be reflected in contract files Must be reflected in contract files Must update job cost records Must update job cost records

Financial Management Equipment Records Equipment Records Assigning cost of equipment to job Assigning cost of equipment to job Depreciation Depreciation Repairs Repairs Maintenance Maintenance Insurance Insurance Operating costs Operating costs Establish per hour rate for equipment Establish per hour rate for equipment Daily rate Daily rate

Financial Management Construction Contracts Construction Contracts Fixed-price / lump-sum Fixed-price / lump-sum Unit-price Unit-price Cost-plus Cost-plus Time and material Time and material

Financial Management Contract Completion Contract Completion How do you know when the job id done? How do you know when the job id done? Percentage of Completion Method Percentage of Completion Method Revenue recognition Revenue recognition Required for tax purposes if $10,000,000 + annual sales Required for tax purposes if $10,000,000 + annual sales Cost to cost Cost to cost Complete Contract Method Complete Contract Method No revenue is recognized until contract is fully or nearly completed No revenue is recognized until contract is fully or nearly completed

Financial Management Accounting Unique to Contractors Accounting Unique to Contractors Accounting for Retainages Accounting for Retainages Accounting for Overhead Costs Accounting for Overhead Costs Provision for losses on Uncompleted Contracts Provision for losses on Uncompleted Contracts Cost and Estimated Earnings in Excess of Billings Cost and Estimated Earnings in Excess of Billings

Financial Management Financial Ratios Financial Ratios Liquidity ratios Liquidity ratios Leverage ratios Leverage ratios Activity ratios Activity ratios Profitability ratios Profitability ratios

Financial Management Liquidity ratios Liquidity ratios Current Ratio Current Ratio Quick Ratio Quick Ratio Leverage ratios Leverage ratios Debt to equity ratio Debt to equity ratio Times interest earned ratio Times interest earned ratio Activity ratio Activity ratio Number of days of contract revenue in receivables Number of days of contract revenue in receivables

Financial Management Profitability ratios Profitability ratios Gross profit margin Gross profit margin Net income as a percentage of sales Net income as a percentage of sales Return on beginning stockholders’ equity percentage Return on beginning stockholders’ equity percentage

Financial Management Acquiring Assets Acquiring Assets Lease Lease Purchase Purchase Evaluation of purchase decisions Evaluation of purchase decisions Present value method Present value method Return on investment method Return on investment method Cash payback method Cash payback method

Present value method Present Value Present Value Purchase the equipment if: Purchase the equipment if: The annual costs are < The present value of the annual savings The annual costs are < The present value of the annual savings The cost of the equipment < the present value of the expected return on the equipment The cost of the equipment < the present value of the expected return on the equipment The opportunity cost of purchasing the equipment is < the present value of the savings or expected return. The opportunity cost of purchasing the equipment is < the present value of the savings or expected return. You must consider foregone income You must consider foregone income