Basic Finance

Basic Finance Owning and operating a business requires financial know how. Basic financial operations include understanding what it takes to start-up a business.

Basic Finance Definition: Start-up costs are pre-opening, one-time expenditures incurred to start a new business.

Basic Finance Start-up cost examples: Utilities hook-up Initial equipment costs Site renovation Advertising for opening business Initial salaries (pre-opening) Employee training

Basic Finance Personal Sources of Financing Sweat Equity Personal Savings Mom & Dad Friends & Family Second Mortgage Personal Loan

Basic Finance Personal Sources of Financing continued Bootstrapping Bartering Credit Cards

Basic Finance Business Sources of Financing Business Associates Customers in Hand Suppliers/Vendors Seller Financing Prospective Employees

Basic Finance Business Sources of Financing continued Joint Ventures/Partners Inventory Financing Equipment Financing

Basic Finance Banks – SBA – Lending Programs Commercial Loans Lines of Credit SBA Guarantee Loans

Basic Finance Angel Investors Are less likely to seek controlling interest May want to participate in the business Typically invest in “local” activities Require good rate of return and want out of the investment in 3-7 years

Basic Finance Angel Investors Continued High net worth individuals Typically experienced entrepreneurs or business executives Investment range of $25,000-$500,000 Some prefer to invest in groups

Basic Finance Venture Capital Primarily a U.S. phenomenon Generally are private partnerships or closely-held corporations funded by private and public pension funds, endowment funds, foundations, corporations, and wealthy individuals

Basic Finance Venture Capital Continued Finance new and rapidly growing companies Purchase equity securities Add value through serving on boards, contacts, and future fundraising Take higher risks and expect higher rewards Have a longer-term orientation

Basic Finance Financial Management Balance Sheet Cash Flow Statement Income Statement Ratio Analysis

Balance Sheet

Basic Finance Balance Sheet Definition: Accounting statement that reports a company’s financial position as of a specific moment in time.

Basic Finance Assets: a physical object or right that has a monetary value. Current Assets: assets expected to be used, sold, or realized in cash within one year. Long-Term Assets: tangible assets that are of a permanent or relatively fixed nature.

Basic Finance Liabilities: debts owed by the business. Current Liabilities: debts payable within one year. Long-Term Liabilities: future debts payable beyond the current year.

Fundamental Accounting Equation: Assets = Liabilities + Owners Equity Basic Finance Equity: Owner’s claim against assets after the liabilities have been deducted. Value of what you own - debts you owe = net worth Fundamental Accounting Equation: Assets = Liabilities + Owners Equity (net worth)

Basic Finance Example Balance Sheet

Basic Finance

Basic Finance Answer Key

Cash Flow

Basic Finance Why does an entrepreneur worry about cash management? Cash pays operating expenses Cash pays for inventory, equipment, and expansions Cash flows vary over time Cash pays the entrepreneur!

Cash flows through a business in a circular manner. Basic Finance Cash flows through a business in a circular manner. Purchases Cash Sales Accounts Receivable Accounts Payable

Basic Finance Components of Cash Flow: Inflows/Income: Owner’s Cash on Hand Cash Sales Accounts Receivable Loans Received Investors Cash

Basic Finance Components of Cash Flow: Outflows/Expense: Inventory Purchased Operating Expenses Insurance, Utilities Employee Salaries Repay Loans Taxes

Basic Finance Making Projections: Be honest Base forecasts on defensible data Complete “what-if” scenarios Be accurate

Basic Finance Example Cash Flow Day 1 Day 2 Day 3 Day 4 Day 5 Beginning Balance $25.00 ($5.00) $12.50 $16.00 $14.50 Cash Receipts $ 7.50 $ 12.50 $8.50 $3.50 $7.00 Loan Receipts $ - $ - Owner's Investment, Outside Resources Total Cash Available $32.50 $7.50 $21.00 $19.50 $21.50 Cash Disbursements Purchases (Cost of Goods Sold) $ 30.00 Advertising Expense $ 2.50 Wages Expense $ 5.00 $ 5.00 Utilities Expense Miscellaneous Expense Total Cash Disbursement $37.50 Ending Balance $16.50

Basic Finance Methods of improving cash flow: Lease equipment versus purchasing Hire contract labor Exchange products/services instead of paying cash

Basic Finance Methods of improving cash flow continued: Negotiate favorable rent terms Monitor accounts receivable Negotiate prepayment on new orders Give discounts for cash Use MASTERCARD, VISA wisely

Income Statement

Basic Finance Definition: The income statement is a summary of the revenues and expenses of the business for a specific period of time. Usually reported monthly and cumulative by month throughout the year.

Basic Finance Example Income Statement Income statement format: Sales $5000 Cost of goods sold (-) $1600 Gross profit $3400 Operating expense: Marketing expenses (+) $800 Salary expenses (+) $400 Utilities expense (+) $200 Total operating expense (-) $1400 Operating income $2000 Interest expense (-) $100 Earnings before taxes $1900 Income tax (-) $532 Net Income $1468

Ratio Analysis

Basic Finance Ratio Analysis: A ratio is a comparison of two numbers. Management, bankers, creditors, financial analysts, and others use ratio analysis to evaluate and compare financial information within a company, between companies, and within industries.

Basic Finance Why do we calculate financial ratios? Evaluation Comparison Projections Remember, when doing any type of financial analysis, we are looking at current and trend.

Basic Finance Ratio Analysis Types: Profit Ratios Liquidity Ratios Leverage Ratios Activity Ratios Growth Ratios

Basic Finance Profitability Ratio Definition Profitability ratios measure a firm’s financial returns on activities. Gross Profit Margin Return on Sales

Basic Finance Gross Profit Margin (GPM) GPM = Gross Profit / Sales Business owners want to maximize GP since it is what pays the operating expenses, purchases assets, and pays the entrepreneur.

Basic Finance Return on Sales (RS) RS = Net Income Before Taxes / Sales Measure of the profitability on each dollar sold by the business. Again, we want to maximize this figure.

Basic Finance Common Size/Account Comparison Entrepreneurs also look at the percentages of each category (usually against sales) to evaluate efficiency.

Basic Finance Liquidity Ratios: Measure a firm’s ability to meet its current financial obligations. Current Ratio Quick Ratio

Basic Finance Current Ratio (CR) CR = Current Assets / Current Liabilities Rule of Thumb = Should be at least 2, but larger the better.

Basic Finance Quick Ratio (QR) QR = Current Assets – (Inventory / Current Liabilities) Rule of Thumb = Should be at least 1 , but the larger the better.

Basic Finance Liquidity ratio continued

Basic Finance Leverage Ratio Definition: measures the amount of funds provided by the entrepreneur compared to the amount of funds provided by creditors. Debt Ratio

Basic Finance Debt Ratio (DR) DR = Total Liabilities / Total Assets Rule of Thumb = Creditors want a moderate DR for financial flexibility; owners may want a higher DR for control or return issues.

Basic Finance Leverage ratio continued

Basic Finance Activity Ratio: Month 1 Net Income Month 2 Net Income Growth Ratio: Month 1 Activity Ratio Month 2 Activity Ratio

Basic Finance Conclusion An entrepreneur must be creative in developing the financial package. An entrepreneur must remember to seek as many unique means as possible to limit financial risk while obtaining the necessary capital.