CHAPTER 12
FINANCIAL MANAGEMENT
12-1 Financial Planning
FINANCIAL PLANNING
Ongoing Operations
Revenue – all income that a business receives
over a period of time
Expenses - the costs of operating a business
12-1 Financial Planning
FINANCIAL PLANNING
Ongoing Operations
BASIC FINANCIAL EQUATION
Revenue – Expenses = Profit or Loss
Revenue > Expenses = Profit
Revenue < Expenses = Loss
12-1 Financial Planning
FINANCIAL PLANNING
Business Expansion
Businesses expand to be able to serve more
customers, reach unserved markets, and sell
new products.
Costs Associated With Business Expansion
New factories/equipment
Marketing activities planned
New employees/training
Marketing activities implemented
Research new products
Distribute products
Locate new markets
Promote products
12-1 Financial Planning
DEVELOPING BUSINESS BUDGETS
A budget provides detailed plans for the financial needs
of individuals, families, and businesses.
A business budget has two main purposes:
1. Anticipate sources and amounts of income for a
business.
2. Predict the types and amounts of expenses for a
specific business activity or the entire business.
12-1 Financial Planning
DEVELOPING BUSINESS BUDGETS
Sources of Budget Information
• The main source of budget information comes from
the financial records of a business
• The SBA provides guides and tools to help owner’s
predict income and expenses
• Private businesses collect and publish financial
information on similar businesses and industries
• Banks will help new businesses plan a budget
12-1 Financial Planning
DEVELOPING BUSINESS BUDGETS
Budget Preparation
Goals
1. Determine the sources and amounts of income
2. Identify the types of expenses
3. Predict their costs
4. Determine how income will be distributed to cover
expenses
5. Reward investors (if there is a profit)
12-1 Financial Planning
DEVELOPING BUSINESS BUDGETS
Budget Preparation
The Budget Process
• Prepare a list of each type of income and expense
that will be a part of the budget
• Gather accurate information from business records
and other information sources for each type of
income and expense
12-1 Financial Planning
DEVELOPING BUSINESS BUDGETS
Budget Preparation
The Budget Process
• Create the budget by calculating each type of
income, expense, and the amount of net income or
loss.
• Explain the budget to people who need financial
information to make decisions
12-1 Financial Planning
TYPES OF BUDGETS
• START-UP BUDGET – plans income and expenses
from the beginning of a new business or major
business expansion until it becomes profitable.
• OPERATIING BUDGET – describes the financial
plan for ongoing operations of the business for a
specific period. (usually planned for 3, 6, or 12
months)
• CASH BUDGET – an estimate of the actual money
received and paid out for a specific period.
12-2 Financial Records & Financial
Statements
FINANCIAL RECORDS
Used to record and analyze the financial
performance of a business.
• They provide detailed information about the
financial activities of the company.
• Local, state, and federal governments require
some records.
12-2 Financial Records & Financial
Statements
FINANCIAL RECORDS
Types of Records
• Asset Records – identify the buildings and equipment
owned by the business, their original and current
value, and the amount owed if money was borrowed
to purchase the assets.
• Depreciation Records – identify the amount assets have
decreased in value due to their age and use.
• Inventory Records – identify the type and quantity of
resources and products on hand along worth the
current value of each.
12-2 Financial Records & Financial
Statements
FINANCIAL RECORDS
Types of Records
• Record of Accounts – identify all purchases and
sales made using credit.
– Accounts payable: identifies the companies from
which credit purchases were made and the amounts
purchased, paid and owed.
– Accounts receivable: identifies customers that made
purchases using credit and the status of each account.
• Cash records – list all cash received and spent by
the business.
12-2 Financial Records & Financial
Statements
FINANCIAL RECORDS
Types of Records
• Payroll records – contain information on all
employees of the company, their
compensation, and benefits.
• Tax records – show all taxes collected, owed,
and paid.
12-2 Financial Records & Financial
Statements
FINANCIAL STATEMENTS
• ASSETS – what a company owns
• LIABILITIES – what a company owes
• OWNER’S EQUITY – the value of the owner’s
investment in the business
12-2 Financial Records & Financial
Statements
FINANCIAL STATEMENTS
• Financial Statements – reports that sum up
the financial performance of a business
• Balance sheet – a company reports its assets,
liabilities, and owner’s equity
• Income statement – sales, expenses, profits
(losses) for a specific time period are reported
12-2 Financial Records & Financial
Statements
FINANCIAL STATEMENTS
The Balance Sheet
12-2 Financial Records & Financial
Statements
FINANCIAL STATEMENTS
The Balance Sheet
12-2 Financial Records & Financial
Statements
FINANCIAL STATEMENTS
The Income Statement
12-2 Financial Records & Financial
Statements
FINANCIAL STATEMENTS
The Income Statement
12-2 Financial Records & Financial
Statements
FINANCIAL STATEMENTS
The Income Statement
Revenue – all income received by the business
during the period.
Expenses – all the costs of operating the business
during the period.
Net Income – when revenue is greater than
expenses.
Net loss – when expenses are greater than income.
12-3 Payroll Management
Payroll Systems
Payroll – the financial record of employee
compensation, deductions, and net pay.
Payroll System – maintains information on each
employee to be able to calculate the company’s
payroll and to make the necessary payments to
each employee.
12-3 Payroll Management
Payroll Systems
How are employees paid?
• Weekly, bi-weekly, monthly
• Hourly, salary, commissions, bonuses, profit
sharing
• Benefits: insurance, vacation, sick leave PTO,
retirement plans, education assistance
12-3 Payroll Management
Payroll Systems
Payroll Taxes
• Income Taxes – federal government, most
states, some local governments require
employers to withhold income tax from their
employees’ pay.
12-3 Payroll Management
Payroll Systems
Payroll Taxes
• Social Security and Medicare
– FICA (Federal Insurance Contributions Act)
– The government requires employers to withhold
and deposit these contributions from employee’s
paychecks along with matching contributions by
the employer.
12-3 Payroll Management
Payroll Systems
Payroll Taxes
• Unemployment Taxes
– Employers pay Federal Unemployment Tax (FUTA)
– The FUTA rate is 6.0% and employers can take a
credit of up to 5.4% of taxable income if they pay
state unemployment taxes. This amount is
deducted from the amount of employee federal
unemployment taxes you owe.
12-3 Payroll Management
Preparing A Payroll
Payroll records – documentation used to
process earnings payments and record each
employee’s pay history.
12-3 Payroll Management
Preparing A Payroll
Preparing Paychecks
Earning Report – provides information for the
current pay period as well as the cumulative
amounts for the year.
Direct Deposit – the employer does not receive
a printed paycheck but is given a receipt of the
funds transfer.
12-4 Financial Decision Making
USING FINANCIAL INFORMATION
Important Financial Information
Balance Sheet
Reporting assets, liabilities and Owner’s Equity
Income Statement
Reporting Sales, expenses and profits (loss)
12-4 Financial Decision Making
USING FINANCIAL INFORMATION
Understanding Financial Performance Ratios
Financial performance ratios: comparison of a
company's financial elements that indicate how
well the business is performing.
12-4 Financial Decision Making
USING FINANCIAL INFORMATION
Understanding Financial Performance Ratios
CURRENT RATIO =
Current Assets
Current Liabilities
DEBT TO EQUITY RATIO =
Total Liabilities
Owner’s Equity
RETURN ON EQUITY RATIO =
Net Profit
Owner’s Equity
NET INCOME RATIO =
Total Sales
Net Income
12-4 Financial Decision Making
USING FINANCIAL INFORMATION
Understanding Financial Performance Ratios
Current Ratio: Current assets compared to the
current liabilities.
• Current assets are those that the business could
convert to cash within one year.
• Current liabilities are all payments owed to
creditors that must be made within one year.
• A healthy business will have a 1:1 ratio.
12-4 Financial Decision Making
USING FINANCIAL INFORMATION
Understanding Financial Performance Ratios
Debt to Equity Ratio: the company’s liabilities
divided by the owner’s equity
• Tell you how much the business is relying on the
money borrowed from others that will have to be
paid back rather than money provided by the
owner.
• Banks want to see a debt to equity ratio of 1:1,
but no greater than 2:1
12-4 Financial Decision Making
USING FINANCIAL INFORMATION
Understanding Financial Performance Ratios
Return Equity Ratio: the net profit of a business
compared to the amount of owner’s equity
• The return on equity ratio shows the rate of
return the owners are getting on the money
they invested in the company.
12-4 Financial Decision Making
USING FINANCIAL INFORMATION
Understanding Financial Performance Ratios
Net Income Ratio: the total sales compared to
the net income for a period of time (6-12
months)
• The net income ratio shows how much profit
is being made by each dollar of sales for the
period being analyzed.
12-4 Financial Decision Making
MAKING FINANCIAL DECISIONS
Managers are responsible for the financial health of
their company and for the specific areas of the
company under their control.
• They regularly check to see if income and
expenses are meeting budgeted amounts.
• Income should be as high or higher than planned.
• Expenses should not exceed the budgeted
amount.
12-4 Financial Decision Making
MAKING FINANCIAL DECISIONS
Managers get regular financial reports and
examine them carefully, looking for
discrepancies (differences between actual and
budgeted performance)
12-4 Financial Decision Making
MAKING FINANCIAL DECISIONS
Lastly, managers need to make adjustments. If
income and expenses are similar to the budget,
he will not need to take action.
If there are financial problems, managers will
take corrective action to try to bring
performance back in line with the budget.