1. Plan and Track Your Finances Unit 5

2. Assess Your Financial Needs Your financing needs will vary depending on the size and type of business you start. Before you can approach a lender or investor, you will have to prepare some financial documents ▫Estimate your startup costs ▫Create a personal financial statement ▫Prepare pro forma financial statements  Cash flow statement, income statement, balance sheet

3. Startup Costs You want to be sure you have accounted for all of the items you will need Common startup expenses include the following: ▫Equipment and supplies (computers, telephones) ▫Furniture and fixtures (desks, chairs) ▫Vehicles (delivery trucks) ▫Remodeling (electrical, plumbing expenses) ▫Legal and accounting fees ▫Licensing fees

5. Personal Financial Statement Begin assessing your net worth ▫The difference between assets (items of value that you own) and liabilities (amounts you owe) Net worth is also referred to as owner’s equity Personal financial statement = personal assets – personal liabilities

7. Equity Capital There are two types of financing available: ▫Equity ▫Debt financing You must consider your company’s debt-to- equity ratio ▫The relation between the dollars you have borrowed and the dollars you have invested in your business ▫This ratio measures how much money a company can safely borrow over time

8. Equity Capital Total Liabilities ÷ Total Equity A high ratio indicates that a business is mostly financed through debt A low ratio indicates that a business is primarily financed through equity ▫The debt-to-equity ratio can vary among industries Lenders and investors look at the debt-to-equity ratio to assess risk. ▫Lenders prefer a low debt-to-equity ratio

9. Equity Capital Equity capital: money invested in a business in return for a share in the profits of the business ▫Includes money invested by the owner Sources of equity capital include: ▫Personal contributions ▫Friends and relatives ▫Venture capitalists  An individual or a company that makes a living by investing in startup companies ▫Crowdfunding  The use of the Internet to fund a business venture or project by raising money from a large number of people

10. Debt Capital Debt Capital: money loaned to a business with the understanding that the money will be repaid within a certain time period, usually with interest ▫Borrow money from friends, relatives, and banks

11. Commercial Bank Loans Secured Loans: loans that are backed by collateral ▫Collateral: property that the borrower forfeits if (s)he defaults on the loan.  Real estate, savings accounts, life insurance policies, stocks, and bonds Types of secured loans include the following: ▫Line of credit ▫Long-term loan ▫Accounts receivable financing ▫Inventory financing Unsecured Loans: not guaranteed with collateral ▫Only made to the bank’s most creditworthy customers  Usually short-term loans

12. Types of Secured Loans Line of Credit ▫An agreement by a bank to lend up to a certain amount of money whenever the borrower needs it  Banks will charge a fee; but funds are readily available Long-Term Loan ▫A loan payable over a period longer than a year  Generally made to help a business make improvements Accounts Receivable Financing ▫The balances owed by customers  Bank usually will loan a business up to 85% of the total value of its accounts receivable Inventory Financing ▫When banks use a business’s inventory as collateral for a loan  Banks usually require that the inventory value be at least double the amount of the loan

13. Reasons a Bank May Not Lend Money The business is a startup Lack of: ▫A solid business plan ▫Adequate experience  You will have to show that you are familiar with the industry and you have the management experience ▫Confidence in the borrower  Making a bad impression Inadequate investment in the business ▫Banks are suspicious of owners that do not invest their own money in their business

14. Other Sources of Loans Small Business Administration (SBA) ▫Offers numerous loan programs ▫Must meet certain requirements Small Business Investment Companies (SBICs) ▫Privately owned and operated investment firms Department of Housing and Urban Development (HUD) ▫Provides grants to cities to help improve impoverished areas Economic Development Administration (EDA) ▫A division of the U.S. Department of Commerce that partners with distressed communities to foster job creation Governments ▫Assistance at the state level

15. Pro Forma Financial Statements

16. Cash Flow Statement For many, the cash flow statement is the most important financial statement ▫It is an accounting report that describes the way cash flows into and out of your business over a period of time ▫It shows how much money you have available to pay your bills and whether you have enough money to continue operating

17. Forecast Receipts and Disbursements To create a pro forma cash flow statement, you will need to estimate your monthly cash receipts and monthly cash disbursements ▫Cash receipts include:  Cash sales, collected accounts receivable, tax refunds, and funds from loans and investors When you forecast the amount of your cash receipts, you need to analyze the demand for each of your products/services ▫You will also need to know the price you will charge for each item

19. Cash disbursements may include payments for cost of goods, accounts payable, rent, salaries, taxes, office supplies, utilities, insurance, advertising, loans, and other expenses

20. Prepare the Cash Flow Statement You should create monthly pro forma cash flow statements for the first year of operation ▫Annual statements for the 2 nd & 3 rd years  Give both to your lender so they have an estimate of your cash flow over time You will find your net cash flow Cash Receipts – Cash Disbursements = Net Cash Flow

22. Preparing a Cash Flow Statment Preparing pro forma statements helps you anticipate when negative cash flows will occur ▫You have a plan for how to handle or avoid them Many business owners create two cash flow statements: ▫One based on a worst-case scenario  Should project lower cash receipts and high disbursements than you think you will have ▫The other based on a best-case scenario  Project the highest cash receipts and lowest disbursements that your business is likely to have

23. Economic Effects on Cash Flow Changes in the economy can have a dramatic effect on cash flow During good economic times: ▫See large amounts of cash flowing into the company and experience positive cash flows Economic slowdowns cause the opposite When making projections, consider the economic forecast ▫Best to err on the side of caution and make conservative estimates

24. Ways to Keep Cash Flowing Collect cash as soon as possible ▫Having customers use cash rather than credit Pay bills close to the due date ▫Plan your payment to reach the creditor just before or on the due date  Be careful not to send the payment late Keep track of your cash ▫Check the cash balance every day and always know how much you have ▫Get and keep receipts for every purchase you make Lease equipment ▫Often, a large down payment is required when you buy equipment Keep inventory to a minimum ▫Minimize the amount of inventory you stock unless it’s part of your competitive advantage to off a wide selection ▫Avoid large purchases of slow-moving inventory

25. Cash Flow is Cyclical Many businesses have sales that are based on the time of year ▫Flower shops, bridal shops, college book stores You will have to carefully monitor cash flow in the months of low sales ▫You will have fixed expenses regardless of whether the month is typically high-sales or low-sales

26. The Burn Rate How long can I afford to lose money? Burn Rate: the rate at which a company spends cash to cover overhead costs without generating a positive cash flow ▫Typically expressed in terms of cash spent per month  A burn rate of $10,000 means the business is spending that sum every month to cover fixed expenses

27. The Burn Rate $20,000÷$2,000=10 months What would the burn rate be for a business with: ▫Cash on hand of $36,000 ▫Burn rate of $6,250 ▫Cash on hand of $140,000 ▫Burn rate of $11,700 Cash on Hand ÷Burn Rate= Number of Months before Cash Runs Out

28. Income Statement Shows the business’s revenue and expenses incurred over a period of time and resulting profit or loss An income statement helps you: ▫Examine how sales, expenses, and income are changing over time ▫Forecast how well your business can expect to perform in the future ▫Analyze your costs to determine where you may need to cut back ▫Identify categories of expenditures you may want to increase or decrease

29. Prepare a Pro Forma Income Statement Preparing a pro forma income statement for a number of years will help lender see the long-term growth of your business Consists of the following parts: ▫Revenue  Money a company receives from its normal business operations ▫Cost of Goods Sold  The cost of the inventory that a business sells ▫Gross Profit  The difference between revenue and cost of goods sold ▫Operating Expenses  Costs necessary to operate a business ▫Net Income before Taxes ▫Taxes ▫Net Income after Taxes

31. Balance Sheet Financial statement that lists what a business owns, what it owes, and how much it is worth at a particular point in time The Accounting Equation: Assets = Liabilities + Owner’s Equity

32. Prepare a Pro Forma Balance Sheet You must estimate the amount of assets, liabilities, uncollectible accounts, and asset depreciation Types of Assets: ▫Current assets  Can be converted to cash easily (cash, inventory, supplies, and accounts receivable) ▫Fixed assets  Cannot be converted into cash easily, will be used for many years (buildings, furniture, and computers)

33. Pro Forma Balance Sheet Types of Liabilities: ▫Long-term liabilities  Debts that are payable over a year or longer (mortgage) ▫Current liabilities  Debts that are due to be paid in full in less than a year (accounts payable) Reductions in Assets: ▫Allowance for uncollectible accounts  The amount that a company estimates it will not receive from customers ▫Depreciation  The lowering of an asset’s value to reflect its current worth

36. Recordkeeping for Businesses

37. Cash or Accrual Accounting Methods Cash ▫Revenue is not recorded until money is actually received and expenses are not recorded until they are actually paid  Cash flow statement is prepared using the cash method Accrual Method ▫Transactions are recorded when the order is placed, the item is delivered, or the service is provided, regardless of when the money is actually received or paid

38. Choosing an Accounting Method Typically, only very small businesses use the cash method ▫The accrual method is used by most companies because it offers a better picture of long-term profitability A business must use the accrual method if: ▫It has sales of more then $5 million a year, or ▫It stocks an inventory of items that will be sold to the public and has sales over $1 million a year

39. Recording Transactions A transaction is any business activity that changes assets, liabilities, or net worth ▫Must keep accurate records of ALL transactions Journals: accounting records of all transactions ▫Sales Journal  Record ONLY sales of merchandise on account ▫Purchases Journal  Record ONLY purchases of merchandise on account ▫General Journal  Record transactions that do not fit in any other journal ▫Cash Receipts Journal  Record ONLY transactions for cash sales and cash payments received from customers on their credit accounts ▫Cash Payments Journal  Record ONLY cash payment transactions where cash, check, or electronic payment has been made

40. Recording Transactions Ledgers ▫Businesses also use a general ledger that is made up of accounts ▫The general ledger will have an account for every type of asset, liability, revenue, expense, and so on ▫Transactions entered into the journals are posted to the general ledger accounts affected by the transaction.  Posting is typically done every one to two days to keep the ledger current

41. Recording Transactions Aging Table ▫Recordkeeping tool for tracking accounts receivable ▫Shows a business how long it is taking customers to pay their bills  Helps identify problem customers

42. Business Records Good recordkeeping can help you make smart business decisions Incomplete or inaccurate records can cause you to mismanage your business or can cause serious legal problems ▫Need to keep accurate banking, payroll, and tax records  Can be kept manually or electronically

43. Banking Records You will need to open a separate checking account for your business ▫You will use your business account for all deposits and withdrawals related to the business Balance your account ▫This will prevent you from accidentally writing checks you don’t have enough money for ▫Computer programs will automatically balance your accounts

44. Payroll Records A payroll is a list of people who receive salary or wage payments from a business ▫Payroll records will show  how much your employees have earned during each pay period  Deductions that may have been made from those earnings for taxes and benefits You can have a computer program help you maintain these records ▫Or hire a payroll service

45. Payroll Records You will need to complete a payroll register for every pay period The register will include the following information for each employee: ▫Employee name ▫Number of hours worked ▫Regular and overtime earnings ▫Federal, state, and local taxes deducted ▫Social security and Medicare contributions deducted ▫Deductions for benefits  Health insurance, life insurance, retirement saving plans

46. Tax Records Income Tax ▫Businesses that earn profits must pay income tax  These are paid quarterly ▫Income tax is prepaid at the beginning of a quarter  You will need to estimate Payroll Taxes and Deductions ▫By law, you are required to deduct taxes from your employees’ paychecks and submit these taxes to the gov’t  You are also required to pay unemployment insurance taxes and a portion of S.S. and Medicare Sales Tax ▫In most states, retail businesses are required to charge sales tax on goods/services  Every month you will have to deposit the tax you collect into a special bank account

47. Activity Assume that you are Kim Smith, the owner of Photo Memories Refer to the aging table on pg. 268 You have decided that no more orders will be filled for Mark Stern until his account balance is paid in full Write a letter to Mr. Stern to inform him of your decision. ▫Provide payment options to help Mr. Stern pay off his account balance