the power of numbers

Chapter 10 10-1Copyright © 2007 by Nelson, a division of Thomson Canada Limited.

The Power of NumbersThe Power of Numbers


…the cheApest money you can find is already in your business – manage

assets


Financial Management System

Budgeting•The Business Plan expressed in dollars

•Forecasting tool

•Break-Even Point

Record Keeping – Accounting

• Funds coming in• How money is spent• Limitations

Reporting – Income Statement, Balance Sheet, Cash Flow•Preparation•Presentation•Decision Making


Get AdviceGet Advice

• If finance is not your strength, you do not have to do it yourself.

• Network to find people who can provide financial help.

• Make a list of possible financial advisors (Table 10.1) a mentor a business guru—how about a banker, real estate broker or a

retired business person a financial advisor or business broker personal financial coach

• Assemble a financial team (Action Step 46).


Record Keeping - Accounting

Accounting is the central activity in economic life

Collection and representation of all economic activity of the business/organization

Measures Managerial effectiveness not behaviour/effort

Strong bias towards results instead of inputs

Principal Tool is the General Ledger – breaks financial activity into various components of income and

expenses

Managerial vs FinancialSummaries drawn from Recording results of day-to-day

accounting records Used to report to the outside

Used to report within


General LegerGeneral Leger

Principles of the General Leger

IN OUT # Consulting Expenses GST Auto Rent Phone Hydro Gas (Heat) GST

$1,070.00 $1,000.00 $70.00$432.00 $403.75 $28.25$750.00 $750.00$57.00 $53.27 $3.73

$210.00 $196.26 $13.74$7,500.00 $7,000.00 $9.34 $490.66

$119.00 $111.20 $7.80

$8,570.00 $1,568.00 $8,000.00 $9.34 $560.66 $403.75 $750.00 $53.27 $111.20 $196.26 $53.52


Accounting – Centres of Control

Assumes you can measure results – sales,

Cost Centres – maximize output given a certain input (budget) OR minimize input to achieve a given output (target)

What is the greatest risk?

Profit Centres – maximize profits by adjusting the input mix, output quantity and price - measured by the difference between actual and budgeted profit


Investment Centres – allocate given funds to specific projects and measure ROI (profit relative to asset base)



Reporting – Income Statement

Also known as a Profit and Loss Statement

Measures costs/expenses against revenues over a defined period of time: First Quarter, Period ending December 31, 2001 etc.

Shows net profit or loss of the business for the entire period – a picture of the results during the accounting period

Main Components:

Sales – all revenue

Cost of Sales – total price paid for inventory, mfg of products during that time

Business Expenses – direct and indirect expenses related to running the Business


Income StatementIncome Statement

• A projected or pro forma income statement is:– An itemized statement of sales (or revenues) and corresponding

expenses over a period of time.

• Normally an income statement is for a one year period (sometimes on a quarterly or even monthly basis)

• Major elements of an income statement include: – sales - cost of goods sold– gross profit - operating expenses – other expenses - net profit

Remember: Profit is necessarily not cash.

• Action Step 49 will help you project your own income statement.


Income Statement

Sales Revenue – operating revenue :- the benefits from the sales of the product or service

non-operating revenue : non-operations related items (interest, sales of assets)

Cost of Goods Sold (Sales) - inventory cost associated with a particular sale (raw materials, certain processing costs)

beginning inventory + purchases – ending inventory = COGS

Operating Expenses - costs incurred by firm in its operations (rent, payroll, utilities, sales taxes,advertising depreciation expense)

Net Income (Loss) = Sales Revenue - COGS (Gross Profit)

– Operating / Other Expenses (before taxes)


Income Statement Sample – Discovery Books (pg 256) – Pro-forma Table 10.8

SalesDirect (cash)RetailInternet

Cost of Goods Sold

Royalties

ExpensesSalariesPayroll TaxesDepreciation on “equipment”Workers CompensationHealth InsuranceAdvertisingOffice SuppliesRentUtilitiesBad debtsTravelMiscellaneousInterest

Taxes

Gross Profit = Sales-COGS

Net Profit

“Bottom Line”


Key Key Income Statement Ratios

• Income statement ratios help to determine how healthy your business is and how it compares to other businesses in your selected industry.


Key Key Income Statement Ratios

Four key income statement ratios are:

1. Gross profit margin = Gross Profit / Total Sales

2. Profit margin = Net Profit / Total Sales3. Return on Investment (ROI) = net profit /

total assets

4. Return on owner investment = net profit / owners’ equity


The Ending Balance Sheet and Key Ratios

• The closing balance sheet provides a final indicator of the financial health of your business

• An example of a typical closing balance is shown in Table 10.10.


Assumptions to Financial Reports

An explanation of the figures in your “projections”

Accuracy is critical to financial projections

Based on market research, industry specific information (Robert Morris Associates Annual Statement Studies, Financial Research Associates)

Projections will only be as accurate as the information you base them upon

Some plans include best case / worst case scenarios


Break-Even Analysis

A break-even level of sales occurs when the sales (revenues) equals total expenses or costs (fixed and variable).

To calculate break-even you will have to know the value of your fixed and variable costs and your output capacity.


Break-Even Analysis

• Two ways to calculate break-even are: 1. unit method. 2. revenue method.

• For many businesses the projected break-even is the first step in establishing its viability.


Break-even ChartBreak-even Chart

• Break-even (target profit) pricing: setting price to break even (or make a target profit) on the total costs of making and marketing a product

• Break-even equals fixed cost divided by (price minus variable cost)

• Used primarily when judging feasibility of a marketing action

• Example (a):• B/E = $300,000/($20 -

$10)• B/E = 30,000 units• Example (b):• B/E = ($300,000 +

$75,000 profit)/($20 - $10)

• B/E = 37,500 units

Figure 12.6


Impact on Reporting

What if……

In the beginning of January the business purchased two new desk top computers and printers (capital) for $10,000 plus $700 GST.

How would this be shown in the January General Ledger?

How would this be shown on the January Income Statement?

How would this be represented on the January Balance Sheet?


Impact on Reporting

What if……

In the beginning of January the business borrowed $6,000 for three months (1.5% / month) to bridge finance the computer purchase.

How would this be shown in the January General Ledger?

How would this be shown on the January Income Statement?

How would this be represented on the January Balance Sheet?


Plotting Your Future Plotting Your Future ChecklistChecklist

Do you have a financial vision? What are your estimated start-up costs? Validate your sales forecast. Identify all your cost and pricing assumptions. Prepare an opening balance sheet. Prepare a monthly cash flow. What is your fallback position if your sales forecast and cash flow

do not reach expectations? Prepare a projected income statement and closing balance sheet. What concerns might a banker have? What would be your

response? Is your break-even within range of your minimum sales forecast? How do your financial ratios compare to industry averages?


Financing A Business Financing A Business Case StudiesCase Studies

Case Study 1: Your Business• If you are ready with the financial information

for your business, prepare:An opening balance sheet.A projected monthly cash flow for the first year of

operation.A projected income statement for the first year. An ending balance sheet after the first year of

operation.


Show me the money……


Arranging Finances

Personal Funds 66% of Start-upsSavings, cash investments, RRSPCarCredit cards, mortgaging property

“Love Money” 12% of new business start-up

Family, friends, other people

If you decide to borrow from family and friends: Do not accept more money than your lender can afford to lose Put everything in writing Make it a business loan Include in the loan a provision for repayment Discuss you company’s goals and any potential problems

Get independent advice

Probably your most important and only source


Banks (most popular external source)Term Loan (time bound)Operating loan – Line of Credit

GovernmentFederal (Business Improvement, Small Business Loan Act)Provincial (Ministry of Economic Development and Trade)

Venture CapitalFunds (4 or 5 out of 100 proposals)“Angels” (less than $50,000)Communities (matching investors with entrepreneurs)Province (supported venture capital programs)Institutions (York University Alumni Club)


Arranging Finances

Find Money in Start-upSuppliers – Inventory Buying PlanLeasing vs. BuyingLeasehold ImprovementsAdvance Payment of Customers


Financing by Financing by Stage of Business DevelopmentStage of Business Development

Types of Start-up Financing Usage Rates by Start-Ups (%)

Informal Type(s)

Personal Savings of owner(s) 66

Personal Credit line of owner(s) 23

Personal Loans of owner(s) 19

Loans from owner(s) friends/family 12

Formal Types

Commercial loans and credit lines 29

Leasing 12

Commercial credit cards 8

Government grants or loans 5

Table 11.1Table 11.1


Strategies for Seeking Finances

Pick the right lending agency

Research applications beforehand

Don’t go “unannounced”

Come prepared

Show them you know your field

Know exactly how much you want

Don’t beg

Think before you sign


Formal FinancingFormal FinancingPrepare to Meet Your BankerPrepare to Meet Your Banker

Some strategiesSome strategies

Make your banker part of your team

Try not to surprise your banker

Invite your banker to your business

Respect the banker’s rules

Have an up-to-date plan

Get ready for collateral, personal and spousal guarantees

Understand the banker's discretionary limits


Your Credit HistoryYour Credit History

Credit refers to the money loaned or the ability to borrow money.

A lender will need to review your credit history and will probably request a credit report.

Key factors for making a decision about your credit are—in order of importance:

• How you pay your bills. • Amount of money you owe and the amount of available credit.• Length of credit history.• Mix of credit.• New credit applications.

What is your credit history?•You’ll need a copy of your credit report—it’s free from three credit reporting agencies. (See Action Step 50.)


Unsecured CreditUnsecured Credit

• Unsecured credit is credit extended to a borrower on the promise to repay the debt with no collateral or guarantee.


Unsecured CreditUnsecured Credit

• Before you start your business you are encouraged to determine you how much unsecured credit you have and: Check out your health and medical insurance

needs. Apply for additional credit cards or increased

limits. Apply for a personal line of credit—which will

depend on the four Cs (capital, character, capacity and collateral).

Explore the possibility of a home-equity loan or home-equity line of credit.


“Will that be:

Debit

Or

Equity”


Will that be Debt or Equity?Will that be Debt or Equity?

Equity financing• If you or others invest money in a business

and expect, in return, a portion of ownership, this is called equity financing or ownership investment.

Debt financing• If you or others lend money to a business and

expect to be repaid the full amount plus interest, this is called debt financing.


Will that be Debt or Equity?Will that be Debt or Equity?

How should you finance the business: debt or equity or some combination?• The trick is to find the right balance between

debt and equity—one that will satisfy the needs of You the ownerThe businessThe market


Types of Debt and Equity?Types of Debt and Equity?

Major types of debtfinancing are:

Shareholders loansShareholders loans

Canada Small Business Canada Small Business Financing (CSBF) loansFinancing (CSBF) loans

Operating loans (Line of Operating loans (Line of Credit)Credit)

Term loansTerm loans

Major types of equityfinancing are:• Sole proprietorship or Sole proprietorship or

partnershippartnership– Owner’s personal

investment• Incorporated businessIncorporated business

– Common shares

– Preferred shares

– Convertible debentures


Plotting Your Future Plotting Your Future ChecklistChecklist

What is the total amount of equity you need to establish and operate your business for the first year? Identify all the sources of funds.

Identify your funding shortfall each month from the cash flow, and the funding sources and expected rate of interest.

Are there any government, agency, or foundation funding sources for your venture?

How much, if anything, do you expect from a venture capitalist or angel investor, and what ownership are you prepared to forego?

Who are your prime vendors? What type of purchase agreement do you have with them?

What is your debt-to-equity ratio, and how does that compare to industry ratios?

the power of numbers

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