Small Business Management

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20 Νοε 2013 (πριν από 3 χρόνια και 10 μήνες)

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Understanding the
Numbers: Essential for
the Entrepreneur


A Student Tutorial

Ever thought or said:


“I did not do well in my accounting
and finance classes . I just am not
good with numbers”


“Finance scares me.”


“I try, but I just can’t get it.”

If not, great, but if so, you may try to
avoid accounting and finance. Why is
that a mistake?

Reasons to Learn Finance


There are things you cannot learn
about a company any other way.


If you do not understand financial
statements and what they tell you,
you will be missing some critical
information about the firm.


And hiring someone to do it for you,
DOES NOT WORK!!

Understanding

Financial Statements


Goal: Understand the financial
consequences of decisions



There are three basic financial (or
accounting) statements:


Income Statement


Balance Sheet


Cash Flow Statement


The Goal:
Making
Good
Financial
Decisions


3 types of
financial
statements


Income Statement (1)


Indicates the firm’s profits over a
period of time


Usually monthly, quarterly or
annually


Basic form:


Sales
(Revenues)

Profits

Expenses

Basic
purpose
and format
of an
income
statement

Income Statement (2)


The Income Statement starts with
sales (revenues).

From Sales,
subtract the
Cost
of Goods Sold

to
obtain the
Gross
Profit

Sales (Revenue)

Cost of Goods Sold

Gross Profit

minus

equals

Can you
compute
gross
profits?


= # of units sold X
sales price per unit

Income Statement (3)


What is
cost of goods sold
?

Cost of goods sold is determined by:


The cost of producing or acquiring
a single unit of the firm’s products
or services


The number of units sold

Cost of
goods
sold

=

cost per
unit

X

number
of units
sold

Computing
cost of
goods
sold

Income Statement (4)


Next compute operating income
(earnings before interest & taxes)

From Gross Profits
subtract
Operating
Expenses

to
obtain
Operating
Income

Sales Revenue

Cost of Goods Sold

Gross Profit

minus

equals

Operating Expenses

Operating Income

minus

equals

Can you
compute
operating
income;
also called
earnings
before
interest
and taxes
(EBIT)?

Income Statement (5)


What are
operating expenses
?


In addition to the cost of goods sold, you need
to convince someone to buy what you are
selling. So, you will have;



Marketing expenses


And you have operating overhead

the light
bill must be paid. So, you will have:



General & administrative expenses


And if you have equipment and buildings. You
will have:



Depreciation expense

(More will be said about depreciation later.)


Operating
expenses
include
marketing
expenses,

G&A, and
deprecia
-

tion

Income Statement (6)

A Comment on Operating Income


Operating Income

is the total profit a
firm makes from running the business
before paying creditors (interest
expense) for the use of debt, and
paying income taxes to the
government.


Operating income is the best profit
indicator of how well a company is
doing in its business.


Income Statement (7)


Next we compute earnings before
taxes (EBT)

From Operating
Income, subtract
Interest Expense

to
obtain
Earnings
Before Taxes

Interest Expense

Operating Income

Earnings Before Taxes

minus

equals

Can you
compute
earnings
before
taxes?

Income Statement (8)

Interest Expense: The Cost of
Borrowing Money


A lender charges interest to loan
money, which is shown as interest
expense in the income statement of
the borrower.


Interest expense is the result of the
interest

rate

and the
amount
borrowed
.

Interest
Rate

Amount
Borrowed

Interest
Expense

x

You have
to pay the
banker to
use the
bank’s
money!!

Income Statement (9)

Computing Earning Before Taxes:

An Illustration

If a firm has:

$15,000 in operating income and $50,000
in debt at a 6% interest rate, then:


Operating Income


$ 15,000


Interest Expense


$ 3,000


The Earnings before taxes is:

$ 12,000





Computing
a firm’s
earnings
before taxes


Earnings Before Taxes:

= Operating Income


Interest Expense

= $15,000
-

($50,000 X .06)

= $15,000
-

$3,000 = $12,000

Income Statement (10)


Finally, we calculate net income

From Earnings
Before Taxes
subtract
Income
Taxes

to obtain
the
Net Income

Interest Expense

Operating Income

Earnings Before Taxes

minus

equals

Income Taxes

Net Income

minus

equals

Can you
compute
net
income?


Income Statement (11)

Computing Net Income Illustrated

If a firm has:


Operating Income of


$15,000

Earnings before taxes of


$12,000

And pays 25% on income taxes.


The Net income is:



$ 9,000

Computing
income
taxes to
find net
income

Net Income:

(Earnings before taxes)
-
(Tax rate)*(Earnings
before taxes)


$12,000
-

(25%)*($12,000) =


$12,000
-

$3,000 = $9,000

Income Statement (12)

Sales Revenue

Cost of Goods Sold

Operating Expenses

Gross Profit

Operating Income

Interest Expense

Operating Income

Earnings Bef Taxes

Income Taxes

Net Income

Operating
Activities

Financing Activities

minus

minus

minus

minus

equals

equals

equals

equals

What have we learned about the
income statement?

DO NOT
continue
until you
know and
understand
the format
and
content of
an income
statement.

Income Statement (13)

An Example

The Income Statement for Trimble & Associates:

Sales






$850

Cost of Goods Sold




550

Gross Profit on Sales




$300

Operating Expenses:


Marketing Expenses



90


General & Admin Expenses


80


Depreciation





30



Total Operating. Expenses


$200

Operating Income




100

Interest Expense





20

Earnings Before Tax




80

Income Tax (25%)




20

Net Income





60

Income
from
operating
the
business

Income
after
\
paying
interest

Cost of
borrowing

Income Statement (14)

Summary


The Income Statement answers the
question:


“How profitable is the business?”


The Income Statement reports on five
broad areas:


Sales (Revenue)


Costs of producing or acquiring the
firm’s goods or services


Operating Expenses


Financing costs (interest expense)


Tax payments


Income Statement (15)

Can You Put It Together?

Cost of Goods Sold $250

Depreciation


$ 8

Sales $290

Income Taxes(25%) $ 2

Admin. &Sales Exp. $ 18

Interest Expense $ 6

Organize this Income statement

Put the
pieces
where
they go!!

4. Good
judgment




Gross Profit on Sales


$

Operating Expenses:




Total Op. Exp.


$


Operating Income


$


Earnings Before Taxes $






Net Income



$



Gross Profit on Sales


$

Operating Expenses:




Total Op. Exp.


$



Operating Income


$


Earnings Before Taxes $







Net Income



$

Here You Go!

Cost of Goods Sold $250

Depreciation


$ 8

Sales $290

Income Taxes(25%) $ 2

Admin. &Sales Exp.

$ 18

Interest Expense $ 6

Depreciation


$ 8

Sales $290

Income Taxes(25%) $ 2

Admin. &Sales Exp.

$ 18

Interest Expense $ 6

Cost of Goods Sold $250

40

26

14

8


6

Income Statement (16)

A Concluding Thought


Congratulations!! You should be
able to understand the income
statement and what it is telling you.



We are now ready to examine the
balance sheet, which measures the
firm’s current financial position.


Let’s continue.

Balance Sheet (1)


A Snapshot of a company’s financial
position at a
specific point in time


The Income Statement covers a period in
time (Jan 1


Dec 31, 2007)


The Balance Sheet represents a specific
moment (December 31, 2007)


In its simplest form, the Balance Sheet
is:

Total
assets
always
equal
debt plus
equity
.

Total
Assets

Owner’s
Equity

Outstanding
Debt

Debt & Equity

Balance Sheet (2)

Three main parts


Assets


What the company
owns


Liabilities (Debt)


What the company
owes


Owner’s Equity (Net Worth)


The amount invested by the
owners (stockholders)


The difference between Assets and
Liabilities




Basic
pieces of
the
balance
sheet


Continue

Balance Sheet (3)

Three main parts


Total Assets, the sum of:


Current Assets (Cash, A/R, Inventory)


Fixed Assets (Machinery and equipment,
Buildings, Land)


Other Assets (Long
-
term investments,
Patents)


Debt and Equity, the sum of:


Total Debt, including:


Current debt (Accounts payable, Accrued
expenses, Short
-
term notes)


Long
-
term debt (Long
-
term notes, Mortgages)


Owner’s equity: owner’s investment in
the company

A look
inside the
balance
sheet


-
Cash Flow

2. Forecast

3. Determine
and
evaluate

4. Good
judgment


Balance Sheet (4)

Assets: Current Assets


Current assets are also called gross
working capital


Current assets comprise the assets
that are relatively liquid


Cash


Accounts Receivable


Inventories


Other current assets


(e.g., prepaid expenses)


Current
assets:
the firm’s
“liquid”
assets;
includes
cash and
assets
that can
soon be
converted
into cash

Balance Sheet (5)

Assets: Fixed Assets


Fixed assets include:


Machinery and Equipment


Buildings and Land


The cost of a fixed asset is recorded
in the balance sheet and depreciated
over its useful life.


The Income Statement reports the
depreciation expense for each year.


The Balance Sheet reports the
accumulated

depreciation

depreciation
taken on an asset over all its life.


Fixed
assets
may also
be called
plant &
equipment

Balance Sheet (6)

Depreciating Fixed Assets


Remember that


When a fixed asset is purchased, the firm
pays cash, and so:


Fixed assets increase in the balance
sheet.


Cash decreases in the balance sheet.


But the depreciation expense is
NOT a cash event.


Depreciation expense is recorded in
the income statement


Accumulated depreciation increases
in the balance sheet


There is NO cash involved!!

Depreciation
expense is
NOT a cash
expense!!!

Balance Sheet (7)

Gross Versus Net Fixed Assets


Gross Fixed Assets

is the original
amount paid for a firm’s fixed assets.


Net Fixed Assets

is the
gross fixed
assets

minus the total depreciation
(
accumulated depreciation
) taken on
the fixed assets
.
That is,


Gross fixed

assets

accumulated

depreciation

=

net fixed

assets

-

So:

net fixed
assets =
gross fixed
assets


accumulated
depreciation

Balance Sheet (8)

An Example of Depreciation


You purchase equipment for $10,000
with an expected life of 5 years. How
much will the depreciation expense be
each year, as reported in the income
statement?


$2,000 ($10,000
÷

5 years = $2,000)


What will the balance sheet look like
over the 5 years?


End of Year

1

2

3

4

5

Gross fixed assets

$10K

$10K

$10K

$10K

$10K

Accumulated depre

2K

4K

6K

8K

10K

Net fixed assets

$8K

$6K

$4K

$2K

$0K


Balance Sheet (9)

Assets: Other Assets


Other assets includes intangibles,
such as:


Patents


Copyrights


Goodwill


And for a start
-
up company:


Organizational costs

The firm’s
other
assets



Balance Sheet (10)

Debt And Equity


Remember

Total
assets
MUST
equal
total debt
plus
owner’s
equity

Total
Assets

Owner’s
Equity

Outstanding
Debt

Debt & Equity

Balance Sheet (11)

Debt or Liabilities


Debt is financing provided by a
creditor



Debt is divided in two parts:


Current debt or short
-
term
liabilities


Long
-
term debt

Where
does debt
come
from?



Balance Sheet (12)

Short
-
term Liabilities


Liabilities due within 12 months


Accounts Payable or Trade Credit:


Credit extended by suppliers for the
purchase of inventories


Usually given 30
-
60 days to pay


Accrued Expenses:


Operating expenses that are owed but
not yet paid


Short
-
term Notes:


Short
-
term loans from banks or other
financial institutions

Short
-
term
liabilities
is debt
that must
be repaid
within 12
months


-
Cash Flow

2. Forecast

3. Determine

4. Good
judgment


Balance Sheet (13)

Long
-
term Liabilities


Loans from banks or other sources
that that come due after 12 months


Usually loans to finance long
-
term
capital investments, such as
machinery and equipment.

Long
-
term
liabilities
(debt)

Loans that
come due
after 12
months

Balance Sheet (14)

Owners’ Equity


Owner’s Equity is the money
invested by the owners



Note: They are residual owners, because in
a liquidation, stockholders are paid last


Equity consists of:


Amount invested when purchasing
ownership in the business


Retained Earnings: All the profits
retained in the company (profits not paid
out in dividends to the owners)

Owners
have 2
ways to
invest in a
business:


Buy
stock


Reinvest
all or
part of
the
firm’s
profits

Balance Sheet (15)

Owners’ Equity


Retained Earnings is the
accumulated profits (gains
-
losses) of
the business, less the dividends paid
to stockholders since the firm was
created


Owners’
Equity

Cumulative
Profits

Owners’
Investment

Cumulative
Dividends

Retained
Earnings

Owners’
Equity

Owners’
Investment

Retained
earnings: A
concept
that many
students fail
to
understand.
Do you?


Balance Sheet (16)

An Example

ASSETS


DEBT AND EQUITY


Current Assets


Current Liabilities:

Cash


$50

Accounts payable

$20

Accounts receiv


80


Short
-
term notes

80

Inventories


220

Total current debt

$100

Total current assets

$350

Long
-
term debt

200


Fixed assets:


Total debt:

$300

Gross fixed assets

$960

Common stock

$300

Accum depreciation


-
390

Retained earnings

320

Net fixed assets

$570

Total common equity

$620

TOTAL ASSETS

$920

TOTAL DEBT AND EQUITY

$920

The Balance Sheet for Trimble & Associates:

Balance Sheet (17)

Putting it together

Given the information below, can you
arrange the balance sheet?

Remember: ASSETS = LIABILITIES + EQUITY

Cash



$ 70

Accounts Receivable $ 220

Inventories


$ 310

Total Current Assets $ 600

Gross Fixed Assets $2,500

Accumulated Depreciation $(300)

Net Fixed Assets


$2,200

Assets:

Current Assets







Fixed Assets





TOTAL ASSETS


$ 2,800

FIRST:

ASSETS

Cash



$ 70

Accounts Receivable $ 220

Inventories


$ 310

Total Current Assets $ 600

Gross Fixed Assets $2,500

Accumulated Depreciation $(300)

Net Fixed Assets


$2,200

Balance Sheet (18)

Putting it together

Common Stock


$ 900

Long
-
term debt


$ 800

Total Owners’ Equity $1,750

Total Debt


$1,050

Total Current Liabilities $ 250

Short
-
term Notes


$ 20

Accounts Payable


$ 230

Liabilities:

Current Liabilities:








Owners’ Equity:





TOTAL DEBT&EQUITY $ 2,800

NEXT:

DEBT & EQUITY

Retained Earnings


$ 850

Common Stock


$ 900

Long
-
term debt


$ 800

Total Owners’ Equity $1,750

Total Debt


$1,050

Total Current Liabilities $ 250

Short
-
term Notes


$ 20

Accounts Payable


$ 230

Retained Earnings


$ 850

Balance Sheet (19)

All Together


The complete balance sheet is as follows

Assets:

Current Assets







Fixed Assets





TOTAL ASSETS


$ 2,800

Liabilities:

Current Liabilities:








Owners’ Equity:





TOTAL DEBT&EQUITY $ 2,800

Cash



$ 70

Accounts Receivable $ 220

Inventories


$ 310

Total Current Assets $ 600

Gross Fixed Assets $2,500

Accumulated Depreciation $ 300

Net Fixed Assets


$2,200

Common Stock


$ 900

Long
-
term debt


$ 800

Total Owners’ Equity $1,750

Total Debt


$1,050

Total Current Liabilities $ 250

Short
-
term Notes


$ 20

Accounts Payable


$ 230

Retained Earnings


$ 850

Balance Sheet (20)

Income Statement and Balance Sheet

The Income Statement and Balance
Sheet complement each other

January 1

December 31

Balance Sheet
on December
31, 2006

Balance Sheet
on December
31, 2007

YEAR 2007

Income Statement for 2007

Balance Sheet (21)

Concluding Thought


A balance sheet indicates a firm’s
financial position in terms of the
assets owned and how these assets
have been financed by debt and
owner’s equity.


With an understanding of the income
statement and the balance sheet, we
can now look at the Cash Flow
Statement.

DON’T
CONTINUE

if you do
not fully
understand
the balance
sheet!! Go
back until
you have
grasped all
the parts of
the balance
sheet.

Cash Flow Statement (1)

“Cash is King!!


Cash flow problems is a major reason for
small firms failing

even at times when
the business is profitable.


Run out of cash

and your business will fail!


CASH IS
KING is not
some
cliché, but
a principle
you cannot
afford to
violate!

Cash Flow Statement (2)

Accrual versus Cash Accounting


You must understand the difference
between
accrual
-
basis accounting

and
cash
-
basis accounting
.


With the exception of very small
businesses, the income statement
and the balance sheet are based on
accrual accounting.


When accrual accounting is used,
profits and cash flows will not be
equal.

Cash Flow Statement (3)

Accrual and Cash Accounting Again


Recording income and expenses:


Accrual
-
basis:

When there is a commitment


Cash
-
basis:

When money changes hands


Income earned

Expense incurred

Cash received

Expense paid

Accrual
-
basis
accounting

Cash
-
basis
accounting

Cash Flow Statement (4)


Why Profits and Cash Flow

are NOT the Same


The differences between profits and
cash flows can result from:


Sales reported on the Income
Statement include cash
and

credit
sales


Some purchases are financed by
credit

so no cash is involved


Depreciation expense is a non
-
cash
expense.


Income tax on the income statement
may be accrued and paid in later
periods.

Profits will
never tell
you how
much cash
you
generated!!

Cash Flow Statement
(5)


Accrual vs. Cash Again

Which type of accounting would record
the following?

Income tax expense that has not been paid

Insurance premium paid in advance

Customer pays for a good to be delivered

Equipment is sold, with a 30 day note

Customer pays and takes equipment sold

Customer receives a service estimate

Payment of last month’s utility bill

Accrual

Cash

Cash Flow Statement (6)

The Cash Flow Statement answers
a very important question:


“Where did the cash come
from and where did the
cash go?”


Cash Flow Statement (7)

Data Needed to Compute Cash Flows


From the income statement:


Depreciation expense


Operating income


Interest expense


Income tax expense


Changes in the balance sheet at the
beginning of the year (end of last
year) and the balance sheet for the
current year end.

Cash Flow Statement (8)

Changes in the Balance Sheet

that Affect Cash Flows


Cash increases if:


Reduce assets


Borrow more money (increase debt)


Owners invest more in the business


Cash decreases if:


Increase assets


Repay (decrease) debt


Owners withdraw money from the
company

Changes
in the
balance
sheet
affect
cash
flows.

Cash Flow Statement (9)


Cash inflows and outflows result
from three activities:


Operating Activities:

Cash flow from normal operations


Investment Activities:

Cash flow related to the investment
in or sale of assets


Financing activities:

Cash flow related to financing the
firm

Three
activities
cause
cash to
increase
or
decrease


Cash Flow Statement (10)


Operating Activities


Cash flow from operations consists
of the net flow of cash from day
-
to
-
day business activities


Start with


Operating income


Add back


Depreciation expense

(a non
-
cash expense)


Subtract


income taxes

(to work on an after
-
tax basis)


Subtract


increase in net working
capital

Which consists of:


Increase in A/R


(a use of cash)


Increase in inventories

(a use of cash)


Decrease in A/P


(a source of cash)

What is
cash flow
from
opera
-

tions?

Cash Flow Statement (11)

Investment Activities


Investment activities consist of


The purchase or sale of fixed assets
(change in gross fixed assets)


The purchase or sale of other long
-
term
assets (changes in goodwill, patents, etc.)


What is
cash flow
from
investment
activities?

Cash Flow Statement (12)


Financing Activities


Financing activities include:


Paying dividends and interest expense


Increasing or decreasing short
-
term and
long
-
term debt


Increase: borrowing more money


Decrease: paying off debt


Owners invest more or less in business


Buy more stock


Company buys owner’s stock back


What is
cash flow
from
financing
activities?

Cash Flow Statement (13)

Cash Flow Statement for Trimble Associates

Operating Activities


Operating income

$ 100


Plus depreciation


30


Less income taxes


(20)

$ 110


Change in net working capital:


Less increases in A/R

$ (5)


Less increases in inventories


(40)


Plus increases in A/P


5

(40)


Cash flows from operations


$ 100

Investment Activities




Less increase in gross fixed assets


$ (100)

Financing Activities




Less interest expenses

$ (20)


Less dividends paid


(15)


Plus incr in short
-
term notes


20


Plus incr in long
-
term notes


50


Total Financing Activities


$ 35

Increase (Decrease) in cash


$ 5

Change in net
working capital

Cash Flow Statement (14)

Can You Arrange this Cash Flow Statement?

Operating activities:





Plus


Less


Less


Less


Plus


Cash flows from operations:

Investment activities


Less

Financing activities


Less


Less


Plus


Plus


Total financing activities

Increase (Decrease) in cash

Operating Income



$120

Depreciation



$ 40

Taxes




$(30)

Increases in accts receivable $(20)

Increases in inventories


$(10)

Increases in accounts payable $ 5

Increase in gross fixed assets $(90)

Interest expenses



$(30)

Increases in short
-
term notes $ 15

Increases in long
-
term notes $ 30

Dividends paid



$(10)

$100

$ 5

$ 100

$ (90)

$ 5

$ 15

Cash Flow Statement (15)

Interpreting the Cash Flow Statement


To understand what the cash
flow statement is saying, look at
the signs (+ or
-
) of the three
cash flow activities:


Is cash flow from operations positive or
negative?


Is cash flow from investment activities
positive or negative?


Is cash flow from financing activates
positive or negative?

Want to
under
-
stand the
cash flow
state
-
ment?
Look at
the three
cash flow
activities.

Cash Flow Statement (16)

Examples of
Cash Flow Patterns

Using cash flows from operations and financing
to invest in long
-
term assets (fixed assets)

Using cash flows from operations to expand the
business and repay creditors and/or owners

Negative cash flow from operations funded by
selling long
-
term assets and additional financing

Sustaining negative cash flows and investment
to expand the business through financing


(Could be a start
-
up that has yet to break even)

Some of the more important

cash flow patterns are:

CONGRATULATIONS!!

You have completed the task!

Hopefully, your persistence has paid
off and you understand financial
statements much more fully and any
fear of financial statements has been
reduced.

Way to go!!!


Go
Celebrate!