Introduction to Business© Thomson South-Western

ChapterChapterChapterChapter

Financial Management

12-112-1 Financial Planning

12-212-2 Financial Records and Financial Statements

12-312-3 Payroll Management

12-412-4 Financial Decision-Making

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FINANCIAL PLANNING Beginning a business Ongoing operations – Every business activity

costs money. All income a business receives over a period of time is called revenue. Expenses are the costs of operating a business. If revenue is greater than expenses, the

business will make a profit. If expenses exceed revenue, the business will suffer a loss.

Business expansion

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BASIC FINANCIAL EQUATION

Revenue – Expenses = Profit or Loss

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DEVELOPING BUSINESS BUDGETS A budget provides detailed plans for the

financial needs of individuals, families, and businesses. Anticipate sources & amounts of income. Predict the types and amounts of

expenses.

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Sources of budget information If a business has operated for several

years, identifying sources of income and types of expenses will not be difficult.The mains source of that information is the financial records of the business.

Budgeting is much harder for a new business.

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Budget preparation – involves 4 steps 1. Prepare a list of each type of income

and expense that will be a part of the budget.

2. Gather accurate information from business records and other sources for income & expenses.

3. Create the budget by calculating each type of income, expense, and the amount of net income or loss.

4. Explain the budget to people who need financial information to make decisions.

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TYPES OF BUDGETS Start-up budget – plans income and

expenses from the beginning a of a new business or a major business expansion until it becomes profitable.

Operating budget – describes the financial plan for ongoing operations of the business for a specific period. The operating budget is planned for 3 months, six months, or a year.

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Cash budget – is an estimate of the actual money received and paid out for a specific period. A cash budget anticipates that cash will come into a business and that cash will be paid out during each week or month of operation. If a new business is losing money, it still must have adequate cash on hand to pay current expenses.

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FINANCIAL RECORDS – are used to record and analyze the financial

performance of a business. Types of records – commonly maintained to

document the performance of a business. Asset records – name 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 number of products on hand for sale. Adequate records are crucial to correctly determine the number of products sold, damaged, or lost and the current value of that inventory.

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Records of accounts – identify all purchases and sales made using credit. Accounts Payable Record – identifies the

companies from which credit purchases were made and the amount purchased, paid, and owed.

Accounts Receivable Record – identifies customers that made purchases using credit and the status of each account

Cash records – list all cash received and spent by the business.

Payroll records – contain information on all employees of the company, their compensation, and benefits.

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Tax records – show all taxes collected, owed and paid.

Maintaining financial records Business records have to be accurate and

should be kept up to date. Technology is changing the way

financial information is collected. Much of the information is now collected using point-of-production and point-of-sale technology such as scanners, touch screens, and personal digital assistants (PDAs).

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FINANCIAL STATEMENTS Three most important elements of a

company’s financial strength:1. Assets – what a company owns

2. Liabilities – what a company owes

3. Owners’ Equity – the value of the owner’s investment in the business.

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The Balance Sheet The assets, liabilities, and owner’s equity for

a specific date are listed on the balance sheet. Prepared once every 6 months or year.

Left side lists assets – anything of value Current Assets – include cash and those items

that can be readily converted to cash such as inventory and accounts receivable.

Long Term Assets (fixed assets) – are assets with a lifespan of more than a year. Common fixed assets are land, building, equipment, and expensive technology.

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The right side – is divided into 2 categories Liabilities – are amounts owed by the business

to others Current Liabilities – are those that will be paid within a

year. Example – payments owed to banks, payments due to suppliers.

Long-term Liabilities – are debts that will continue for longer than a year. Examples – debts owed for land, buildings, and expensive equipment.

Owners equity – the value of the business after liabilities are subtracted from assets. This shows how much the business is worth.

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The Income Statement To report the revenue, expenses,

and net income or loss from operations for a specific period, a business prepares an income statement. Revenue – all income received by the

business during the fiscal period. Expenses – include operations, purchase

of equipment, supplies, inventory, payroll, and taxes.

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Net Income – Revenue is greater than expenses.

Net Loss – Expenses are greater than revenue.

Business managers review financial information to determine how the business is performing. In addition to comparing financial

performance from one time period to another, the owner will want to make comparisons with similar businesses. A business that is less profitable than similar businesses, or with lower sales or higher expenses, may have difficulty competing.

Introduction to Business© Thomson South-Western

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PAYROLL SYSTEMS

Payroll is the financial record of employee compensation, deductions, and net payroll.

A 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. Compensation to employees – benefits Businesses are responsible for making require

federal and state payments for each employee. These taxes consist of income taxes, Social Security, Medicare, and unemployment taxes and are commonly referred to as payroll taxes.

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Income Taxes – The Federal government require employers to withhold income tax from their employee’s pay. The taxes are based on the amount of wages and income and the number of dependents.Social Security and Medicare (FICA) – Federal Insurance Contributions Act – government requires employers to withhold and deposit these taxes from employee’s paychecks. Employers must also make matching contributions.Unemployment taxes – Employers pay (FUTA) Federal Unemployment Tax to the unemployment insurance system. Employers withhold taxes from wages and make their required contribution.

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Personnel records include: Personal information, employment history Performance evaluation Compensation records

Most information in personnel files is confidential. Because of this, the business must carefully and securely maintain records.

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PREPARING A PAYROLL Payroll records – The form used to

track each employee’s pay history. Name, Social Security Number, Address Individual tax information, and a record of

benefits such as vacation and sick days available and used.

The employee’s current and year-to-date earnings, deductions, gross pay and net pay.

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Preparing paychecks – Earnings Report – includes amount of

deductions for the current pay period. Includes Information for the current pay

period as well as the cumulative amounts for the year.

Direct Deposit – the employer transfers net pay electronically into the employee’s bank account.

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AN EMPLOYEE’S PAYCHECK AND EARNINGS REPORT

SamplePaycheck

SampleEarningsReport

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USING FINANCIAL INFORMATION Important financial information

Managers who understand the information in financial statements will be able to make decisions that result in the wise use of the company’s money.

Understanding financial performance ratios Current ratio – Current assets compared to the current

liabilities. Can pay their debts when they are do. Debt to equity ratio – Companies liabilities divided by the

owner’s equity. How much the business is relying on money borrowed from others.

Return on equity ratio – Net profit of the business compared to the amount of owner’s equity.

Net income ratio – Total sales compared to the net income for a period such as six months or a year. Shows how much profit is being made by each dollar of sales for the period analyzed.

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FINANCIAL PERFORMANCE

RATIOS

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MAKING FINANCIAL DECISIONS Managers are responsible for the

financial health of their company and for the specific areas of the company under their control.

Prepare a budget – use as a guide Look for discrepancies between actual

and budgeted performance

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Make needed adjustments Last adjustment managers could

attempt is to redo the budget. Businesses usually hold managers

responsible if their part of the company faces financial problems.

Managers will be rewarded if they are effective in managing the financial resources of company.