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Progressing to become a leader

TABLE OF CONTENTS 1

TABLE OF CONTENTS

TABLE OF CONTENTS ................................................................................................................................ 1

1. OVERVIEW ........................................................................................................................................... 4

QUOTES........................................................................................................................................................ 5

2. FINANCE, THE LIFEBLOOD OF YOUR BUSINESS........................................................................... 6

3. PERSONAL FINANCE .......................................................................................................................... 8

3.1 Keep business and personal finances separate ........................................................... 8

3.2 Cover both business and personal expenses ............................................................... 8

3.3 Find out about money matters ...................................................................................... 8

3.3.1 What is a Current Account? ................................................................................................... 9

3.3.2 Business accounts ................................................................................................................. 9

3.3.3 Electronic Banking Solutions ................................................................................................. 9

3.3.4 Telephone Banking .............................................................................................................. 10

3.3.5 Cellphone Banking .............................................................................................................. 11

3.4 Personal Finance Management principles .................................................................. 11

3.4.1 Manage credit ...................................................................................................................... 11

3.4.2 Organise your financial matters ........................................................................................... 12

3.5 Plan for retirement ...................................................................................................... 15

3.6 Wealth protection ....................................................................................................... 16

3.6.1 Retirement Annuities ........................................................................................................... 16

3.6.2 Life cover ............................................................................................................................. 17

3.6.3 Saving .................................................................................................................................. 17

4. ACCOUNTING: OPPORTUNITY OR DISADVANTAGE? ................................................................ 18

4.1 Introduction: Where are we now? ............................................................................... 18

4.2 Compiling an Accounts System for the Business ........................................................ 21

4.3 Interpreting the data ................................................................................................... 22

4.3.1 Accounting Equation ............................................................................................................ 25

4.4 Statutory Regulations ................................................................................................. 25

4.4.1 Accounting Records ............................................................................................................ 25

4.4.2 Annual Financial Statements ............................................................................................... 25

4.4.3 Interim Reports .................................................................................................................... 26

4.4.4 Provisional Financial Statements ........................................................................................ 26

4.4.5 Close Corporations (CCs) ................................................................................................... 27

4.4.6 Annual Audit Requirement ................................................................................................... 27

4.4.7 Filing and Disclosure Requirements .................................................................................... 27

4.4.8 Form and Content of Financial Statements ......................................................................... 28

5. MEASUREMENT: CASH FLOW ....................................................................................................... 29

5.1 What is Cash Flow? ................................................................................................... 29

5.2 What is the difference between Cash Flow and Income? ........................................... 29

5.3 What is the Cash Flow Statement? ............................................................................ 30

5.4 Implications of cash flow for the business owner ........................................................ 31

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5.5 Understanding the cash flow statement ...................................................................... 31

5.6 Freeing up the cash in your business ......................................................................... 34

5.7 Cash Flow Summary .................................................................................................. 36

6. COST MANAGEMENT ....................................................................................................................... 38

6.1 Control Reports .......................................................................................................... 39

6.2 Cost Cutting for Small Businesses ............................................................................. 40

6.3 Petty Cash – The small ants in your Organisation ...................................................... 45

7. INTERPRETATION OF FINANCIAL STATEMENTS ......................................................................... 47

7.1 Purpose of Financial Analysis .................................................................................... 47

7.2 Steps for doing a financial analysis ............................................................................ 47

7.3 Analysing Profitability ................................................................................................. 48

7.3.1 Applying Ratios to measure Profitability .............................................................................. 50

7.3.2 Analysing Efficiency of Utilising Resources and Capital ..................................................... 53

7.3.3 Making Recommendations after an Analysis ...................................................................... 56

7.3.4 Identifying Opportunities for Growth .................................................................................... 56

7.3.5 Viability ................................................................................................................................ 56

7.3.6 Evaluating Financial Viability ............................................................................................... 57

7.3.7 Using Liquidity Ratios to Analyse the Organisation’s Viability ............................................ 57

7.3.8 Using Leverage Ratios to Analyse the Organisation’s Viability ........................................... 58

7.3.9 Formulas used to calculate ratios ........................................................................................ 60

8. HOW TO WRITE A 1-PAGE BUSINESS PLAN ................................................................................. 64

8.1 The key elements that need to be contained in any good business plan would be the following: .............................................................................................................................. 64

8.2 Here are five easy steps to a one-page business plan: .............................................. 65

9. TENDERS ............................................................................................................................................ 66

9.1 Winning Tenders ........................................................................................................ 67

9.2 Categories of Tenders ................................................................................................ 69

9.3 Standard Conditions of Tender ................................................................................... 70

9.4 Problems with Tendering ............................................................................................ 71

9.5 Tender Process .......................................................................................................... 71

9.6 Procurement Process ................................................................................................. 72

9.7 Where to find Tender Opportunities ............................................................................ 72

9.8 The Briefing Session .................................................................................................. 73

9.9 Evaluating whether to tender or not ............................................................................ 73

9.10 Evaluating Criteria ...................................................................................................... 75

9.11 Empowerment Criteria ................................................................................................ 76

9.12 Tender Preparation and Submission .......................................................................... 77

9.13 Tender Costing ........................................................................................................... 79

9.14 General Conditions and Procedures: .......................................................................... 80

9.15 Tender Closing ........................................................................................................... 80

9.16 Awarding Tenders ...................................................................................................... 81

9.17 Tender Rejection ........................................................................................................ 81

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9.18 Advice from Seda ....................................................................................................... 82

9.19 Pricing Strategies ....................................................................................................... 83

9.19.1 Types of Contracts............................................................................................................... 83

9.19.2 Finding the break-even point ............................................................................................... 87

9.20 Tender Glossary ......................................................................................................... 90

10. MANAGEMENT CHECKS AND BALANCES – BUDGETS AND FORECASTS .............................. 92

10.1 Key objectives of budgeting ........................................................................................ 92

10.2 Budget process .......................................................................................................... 94

10.2.1 Types of business budgets .................................................................................................. 99

10.3 The importance of controlling working capital ........................................................... 101

10.4 Key areas for controlling working capital .................................................................. 103

10.5 Successful budgeting ............................................................................................... 104

10.5.1 Constructing a budget ....................................................................................................... 105

10.5.2 Controlling a budget .......................................................................................................... 112

11. GLOSSARY....................................................................................................................................... 114

TABLE OF FIGURES Figure 1 – Annual Financial Statements .......................................................................................................6 Figure 2 - Management and Financial Accounting ................................................................................... 20 Figure 3 - Accounting Process ................................................................................................................. 22 Figure 4 - Accounting System .................................................................................................................. 23 Figure 5 - Accounting Equation ................................................................................................................ 25 Figure 6 - Kyosaki Model with inclusion ................................................................................................... 30 Figure 7 - Profit and Loss Analysis ........................................................................................................... 32 Figure 8 - Project Control and Change Management Flow ...................................................................... 38 Figure 9 - Standards ................................................................................................................................. 40 Figure 10 - Cost Control ........................................................................................................................... 41 Figure 11 - Steps to follow for doing a Financial Analysis ........................................................................ 48 Figure 12 - Tender Requester Needs ....................................................................................................... 67 Figure 13 - Empowerment Criteria ........................................................................................................... 76 Figure 14 - Tender Scorecard - Updated 2014 ........................................................................................ 77 Figure 15 – Costing considerations ............................................................................................................ 79 Figure 16 – Contract Risks ........................................................................................................................ 83 Figure 17 – Pricing Strategy ....................................................................................................................... 84 Figure 18 – Pricing Matrix ........................................................................................................................... 86 Figure 19 – Break-even Analysis ............................................................................................................... 88 Figure 20 – Planning Process .................................................................................................................... 94 Figure 21 – Budgeting Process .................................................................................................................. 95 Figure 22 – Balance Sheet Income Statement Process .......................................................................... 102 Figure 23 – Key areas for Controlling Working Capital ............................................................................ 103 Figure 24 – Drawing up a Budget ............................................................................................................. 105

OVERVIEW 4

1. OVERVIEW

As business is becoming increasingly competitive, it is essential that a framework of standards,

competencies and commitment that enables you to stand above the rest be established to achieve

sustainability and consistent growth.

The Progressive Business Forum (PBF) recognises that economic growth is dependent on a

vibrant and effective business community that is able to compete, deliver and ensure quality.

Business success will only be achieved through hard work, capable managers and the right

attitude: an attitude that recognises that achievement cannot be handed over on a silver tray; it

has to be earned.

The role of the business sector is so important for our country. The fight against poverty, the

achievement of sustained economic growth and ensuring a winning nation is largely dependent

on the success of our business community. And in this, the ANC specifically recognises the role

that the small, medium and micro enterprise (SMME) sector has to play, and the work that still

needs to be done to invigorate and further develop it.

To this end, the ANC PBF places a high premium on training and skills development. It has

therefore included as part of its offering to the participants in the programme a “Growth Assist”

component, which contributes towards exposing its participants to expertise and industry best

practice. Through the Progressive Business Leader Training, it also helps equip business leaders

with the necessary knowledge to ensure that the best is achieved for their business, and through

their success, also their workers and our nation.

At the core of the ANC PBF’s ethos is the recognition of the inter-dependence of the business

community, the workers, civil society and government. The primary objective, of creating wealth

for shareholders, cannot be achieved without a concomitant improvement in the working

conditions of the workers that help produce that wealth, and the broader community whose

consumption is required and must be stable in order to achieve sustainability and growth.

A Progressive Business Leader must and does understand this!

Daryl Swanepoel – PBF Convener

Authors: Lesley Coetzee

Jan Coetzee

Helene Strauss

Reviewed: September 2014

OVERVIEW 5

QUOTES

"It's good to have money and the things that money can buy, but it's good, too, to check up once

in a while and make sure that you haven't lost the things that money can't buy."

George Lorimer"

“I have learned to use the word impossible with the greatest caution."

Wernher von Braun

"There's a saying among prospectors:

'Go out looking for one thing, and that's all you'll ever find."

Sir Isaiah Berlin

"Understanding brings control."

Robert Flaherty

"Impossible is a word only to be found in the dictionary of fools."

Napoleon

"If you limit your choices only to what seems possible or reasonable, you disconnect yourself

from what you truly want, and all that is left is a compromise."

Robert Fritz

"We make a living by what we get, but we make a life by what we give"

Winston Churchill

FINANCE, THE LIFEBLOOD OF YOUR BUSINESS 6

2. FINANCE, THE LIFEBLOOD OF YOUR BUSINESS

It is not all about money!

But, without money there is nothing!

In order to survive in the cut-throat world of business, business managers increasingly need

financial management skills. Financial management includes all the financial activities of your

business: financial planning, the implementation of organisational and financial controls and the

drawing up of financial statements.

Yes, there are accountants to draw up financial statements, but how can the manager make

informed decisions if s/he is not able to interpret and correctively apply them?

It is important to understand how to make a profit, what to charge for a product or service and

how to contain or cut costs. Compiling a set of monthly management accounts will assist in the

day-to-day decisions and activities of your business, so that you can manage it proactively, rather

than reactively.

SARS require a business to submit financial statements on a yearly or half-yearly basis to

determine its level of taxation. The business’s annual financial statements include:

Figure 1 – Annual Financial Statements

Business owners usually make some of their important decisions based on the financial

information that accountants prepare. That's why it is important for the business owner to

understand how this information is measured. To facilitate this communication, accountants

establish rules that business people can use to ensure they are talking about the same thing.

All the rules of accounting and accounting measurement are collected in one group called

Generally Accepted Accounting Principles (GAAP) and are subject to certain statutory

regulations. You’ll learn more about GAAP later.

However, financial figures, by themselves, usually do not mean much.

FINANCE, THE LIFEBLOOD OF YOUR BUSINESS 7

You must be able to see the picture and

read the story from the figures

When you compare the financial figures with certain other numbers you can learn much about

how your business is doing; for example, you can compare the planned expenses depicted in

your budget with your actual expenses to see if your spending is on track. You could also use

ratios to analyse the financial figures.

A ratio is a comparison made by dividing one figure by another, such as how salaries are related

to the total expenses for a function, such as sales, to find the implications thereof.

Financial analysis is part of financial management, which includes:

The management and recording of the flow of money.

Planning the future use of money.

Ensuring that the money is well spent and not misused.

Building the financial sustainability of the business.

The biggest problem and root cause of 99% of organisations’ problems lies in the single supply

source for both budgets and the organisation’s bank account.

Our personal finance becomes the biggest problem in our organisation. Therefore let‘s start by

looking briefly at our personal finances before we start with the business’s finances.

This will resolve a major headache in terms of the profitability of the business and keep our

personal finances separate from the business, where they belong.

PERSONAL FINANCE 8

3. PERSONAL FINANCE

Is THIS your reality right now?

Important tips regarding your finances as a business owner:

3.1 KEEP BUSINESS AND PERSONAL FINANCES SEPARATE

This may sound easy, but if you’re not careful, you could start mixing the two without knowing it.

This upsets SARS (South African Revenue Service).

The simplest way to avoid this is to open a separate bank account for your business venture.

Yes, this will take you some time at your local branch, but in the long run it is a step that you have

to take.

3.2 COVER BOTH BUSINESS AND PERSONAL EXPENSES

Many people run into problems when they attempt to expand too fast. In the end, they’re forced

to decide which bills to pay first. You never want to be in a situation where you have to choose

between paying your bond or paying your employees.

3.3 FIND OUT ABOUT MONEY MATTERS

Read the newspapers and watch TV.

Read the brochures that accompany bank statements.

Communicate with the bank and find out which account suits you best.

Know how much interest you are earning and paying.

Know how to save on bank charges and other costs.

Know how to negotiate better deals.

Know how and where to invest and save.

I have to

pay the

rent!

How can I pay

school fees?

PERSONAL FINANCE 9

3.3.1 What is a Current Account?

A current account is a transactional account ideal for individuals earning a regular monthly

income. More sophisticated than a savings account, a current account allows you to transact and

manage your finances in a variety of convenient ways, including via your bank’s branch, ATM’s

nationwide or through Internet, Telephone and Cellphone Banking. Additional optional features

include a cheque book or overdraft facility, which can be managed conveniently through

monthly account statements.

3.3.2 Business accounts

Cheque Account

The purpose of a cheque account is to perform transactions. Businesses maintain cheque

accounts, as part of business management, for deposit, savings and withdrawal purposes.

Where necessary, an overdraft facility can be provided on cheque accounts. This facility

provides businesses with short-term working capital finance.

Bank charges on cheque transactions can be substantially reduced through using Electronic

Banking products.

Features:

Cash is available without notice required.

Itemised statements can be arranged daily, weekly, monthly or on specified dates.

Overdraft facility is available.

The account can process cash and cheque deposits.

Ability to identify depositors.

Cheque accounts can be accessed via Electronic Banking services.

Improves cash management.

Payments can be stopped.

Bank guaranteed cheques available.

3.3.3 Electronic Banking Solutions

Business Internet Banking

Digital Banking products give you instant, secure access to your accounts, anytime, anywhere,

giving you the chance to bank at your desk, on your phone, in your car or even at home.

Features and Benefits

Load, pay and maintain beneficiaries. You have the choice to make the payment

immediately or sometime in the future. This includes once-off payments too.

PERSONAL FINANCE 10

Send notice of payment to yourself or to a beneficiary by SMS, e-mail or fax.

Maintain your own Internet Banking transaction limits, setting a maximum amount allowed

per day.

Put notifications by SMS in place that will notify you of any Internet Banking activities, i.e.

when logon occurs, etc.

Make enquiries about previous statements, payments, debit orders, etc. - all of which can

be downloaded directly into a range of bookkeeping software packages, such as MS

Money and Pastel.

Access transaction history (statements) and archived statements going back as far as 2

years.

Change your personal settings to suit your requirements, including personalised greetings

and language choice (English or Afrikaans).

Update your details.

Purchase prepaid airtime for all the networks.

Authorise other people to transact on your account with certain transaction limits and

access to funds and beneficiaries.

Authorise tax payments.

Stop cheques if you need to.

Load payment reminders that will ensure you never miss a payment again - reducing

interest and penalties for late payments.

Register for iPayroll and provide payslips and IRP5’s for employees, as well as payment

to third parties, i.e. pension funds, provident funds, SARS, UIF, etc directly from Internet

Banking.

Requirements:

To be able to use Internet Banking, you need a personal computer, modem, a browser and an

account with an Internet Service Provider.

3.3.4 Telephone Banking

Available 24-hours a day, 7-days a week - Telephone Banking makes managing your account

easier by being able to transact any time, any place… over the telephone.

Telephone Banking offers a mix of basic transactional type functions, through to more complex

investment management facilities.

Features

Balance enquiries.

Statements (via fax or e-mail).

Inter-account transfers. Accounts payments to pre-registered beneficiaries.

PERSONAL FINANCE 11

Create and change stop orders.

Register new beneficiaries.

Stop payment of cheques.

Link additional accounts to manage portfolios.

Update and manage personal banking details.

Costs:

Calls within South Africa are charged at standard Telkom rates.

Calls from your Cellphone are charged at standard cellular rates.

3.3.5 Cellphone Banking

Cellphone banking service gives you quick, convenient and secure access to your accounts via

SMS anytime, anywhere. This means that you can get account balances, view statements,

transfer funds, pay accounts, top-up airtime, purchase Telkom vouchers and more from

your Cellphone.

Cellphone banking is available to individual and business users.

3.4 PERSONAL FINANCE MANAGEMENT PRINCIPLES

3.4.1 Manage credit

Don’t buy on credit like most people do:

Wait, you don’t need to buy everything right away.

Know your weaknesses.

Know when and where you buy without thinking (impulse buying).

Save for things you want.

Know the real cost of credit.

Don’t mind being called ‘miserly’ or ‘stingy’ by people who don’t know better.

Eating something from the tuck shop every day costs you:

* If you leave R3 468.00 in a savings account for 40 years at 10% interest per year, you will have

approximately R216 000 extra when you retire!

Cost per meal Cost per year

R9.50 R3 468.00*

R10.00 R3 650.00

R11.00 R4 015.00

PERSONAL FINANCE 12

3.4.2 Organise your financial matters

Read all your bank statements.

Read all your account statements.

Keep all your paperwork in a file.

Keep all receipts and invoices.

Keep all contracts.

Draw up a Will*.

Put together a Life Portfolio*.

What is a Will?

A will is a legal document in which you say how your property or estate (house, money, jewellery,

etc.) must be shared after your death.

Checklist for a will:

It must be in writing.

You must older than 16 years.

You must understand what you are doing.

Sign the will on every page.

At least two witnesses, who are older than 14 years, must sign on the last page of your

will.

You must all sign the will in one another’s presence.

Date your will.

Identify the executor of your will.

Update it regularly.

If you leave assets to your children, the law includes:

Children born of your marriage(s).

Children born out of marriage.

Legally adopted children.

Remember that a beneficiary form is not a Will.

Include common-law wives and your children outside marriage.

The funeral:

According to a spokesperson from AVBOB a funeral can cost anything from R5000 to R10000!

PERSONAL FINANCE 13

A typical invoice of formal expenses for a modest funeral:

Casket R7 000

Cross R 200

Ground R1 260

Digger R 360

Programmes R 150

Doctor’s fee R 50

Hearse hire services R 250

TOTAL R9 120

These amounts do not include the thousands spent on catering, flowers, transport and alcohol for

the “after-tears” party.

What can you do?

Take out a funeral policy.

According to a spokesperson from AVBOB, you can get funeral cover for the whole family from

as little as R25 per month.

There are various types of funeral assurance:

Only for your own funeral.

The funeral costs of yourself and your immediate family.

The cost of your extended family’s funerals (brothers, sisters, parents, in-laws).

How to ensure that you do get the benefits you pay for1:

Make sure that the person selling the policy is registered with the Life Offices’ Association

(LOA).

Find out if you are allowed to choose between having the funeral costs paid or having the

benefits paid in cash so that you can pay for the funeral.

1 Information supplied by the LOA consumer education programme

Contact the Life Offices’ Association: 021 421 2586

Contact the Financial Services Board: 0800 110 443

PERSONAL FINANCE 14

Make sure that you receive your policy certificate within 30 days.

Make sure that it contains information on the total amount to be paid out and the person

or people who are covered.

Ensure that you receive a receipt for every cash payment you make.

Keep bank statements showing deductions for the policy in a file.

How to compile a Life Portfolio

In the event of serious illness, accident, or death, your dependants need to be able to trace all

relevant documents.

Keep only photocopies of important documents in this file. The originals should be safely stored

in a safe, at your bank, with your accountant, financial advisor or lawyer.

Put a filing system in place – a concertina file where each item can be stored separately

seems to work best.

Read all statements and check against receipts.

Pay particular attention to debit order deductions, especially if you have cancelled them.

The cancellation at the bank is only valid for 3 months and if a company puts a debit order

through for another amount, the bank allows it.

Put together a “Life Portfolio”: a file in which you keep all personal details, as well as

financial information.

Life Portfolio (Example):

LIFE PORTFOLIO OF …………………….. (full name(s) and surname), ID ……………

Family information:

Relationship Full names and surname ID number/ date of birth

Spouse

Son

Daughter

Passport details:

Full names Nationality Number Expiry date

PERSONAL FINANCE 15

List of personal documents:

1. Birth certificates.

2. Marriage certificate.

3. Ante nuptial contract.

4. Divorce settlement.

5. Adoption papers.

6. Relevant death certificates.

7. Naturalisation papers.

8. Driver’s licence details.

9. Firearm licence/ other licences.

10. Next of kin.

11. Who to contact in an emergency.

12. Details of Executor of Estate.

13. Details of Administrators of Trust.

14. Last Will and Testament.

15. Preferred funeral arrangements.

Important numbers: (example)

Name of company Contract number Contact person Telephone number

e.g. Discovery

Health 5769083 Janet Klein 011 954 4771

Write details that can change in pencil.

Remember to update your Portfolio regularly; in fact, it’s a good idea to include a page on

which you can record when you updated, e.g.

Record of updating:

Date…………/………../…………. Signature…………………

3.5 PLAN FOR RETIREMENT

1. How old do YOU want to be when you retire?

2. How much is your pension going to be?

3. Will it be enough?

Many entrepreneurs regard their business as their main source of retirement capital, hoping to

sell the business to finance their retirement.

PERSONAL FINANCE 16

There are risks attached to this way of thinking:

Your business may not survive until you retire. Being in business is always risky and your

business may be liquidated at a point in your life when it is too late to start saving for

retirement.

You have no guarantee that your business will be sold for the amount you have in mind.

If you have planned to raise R5-million for retirement through the sale of your business

and you only manage to sell it for R3-million, your retirement capital is suddenly reduced

by 40%.

What happens when your pension is not enough?

Government pension?

Will the children look after me?

Do I beg on street corners?

Do I keep on working?

3.6 WEALTH PROTECTION

To protect your retirement capital from the risks of your business, you have to build up a reserve

outside of your business.

3.6.1 Retirement Annuities

Retirement annuities (RA’s) are savings tools tailored specifically for retirement provision, and are

an excellent way for people with their own businesses to provide a pension for themselves.

An RA offers an outstanding, disciplined way of saving, because you have to conclude a contract.

An added advantage is that you can make the RA “paid-up” if your business is struggling. You

simply stop the premium payments, while the contributions already made to the fund are

preserved and continue to grow.

An RA is protected from creditors, which means that even if you are declared insolvent, your RA

cannot be attached.

RA’s are paid out between the ages of 55 and 69 and have specific tax benefits.

You can also have disability and death benefits attached to your RA.

Let’s have a look at what R200 per month can do for you if you are a:

20-year old 30-year old 40-year old 50-year old

R1 182 406 R366 864 R104 319 R19 395

- Pay-out at age 55.

- These amounts are calculated at an interest rate of 12% per year.

PERSONAL FINANCE 17

3.6.2 Life cover

Entrepreneurs should have life insurance to protect their businesses against possible crises, such

as when a partner dies or becomes disabled.

In the case of death, the surviving partners have the problem of a new partner (the deceased’s

next of kin) for whom they have not made provision.

The solution is for the partners to enter into a mutual contract in which they agree that in the case

of death or disability, the surviving partners will buy his/her share from the next of kin. They do

this by mutually insuring each other’s lives (called buy-and-sell insurance).

Remember that taking out life insurance is subject to the state of your health, your medical history

and whether you can afford it- it is therefore important to take out insurance when you are still

young and healthy.

3.6.3 Saving

Start by saving for emergencies and big items: Depositing money in a savings account every

month is a good way to get into the habit of saving.

Look for a good rate.

The more you have in your savings account, the more interest you will earn.

As soon as you have an emergency fund, you can start investing.

Am I keeping my business and personal finances separate, or am I borrowing

to fund one or the other?

Have I made enough provision for retirement?

Have I made provision for wealth protection?

Do I know enough about my personal finances, or am I leaving it in others’

hands?

References and acknowledgements:

1. Helene Strauss. Steps to Financial Freedom. 2009. Johannesburg: Jacana Custom Publishing

ACCOUNTING: OPPORTUNITY OR DISADVANTAGE? 18

4. ACCOUNTING: OPPORTUNITY OR DISADVANTAGE?

4.1 INTRODUCTION: WHERE ARE WE NOW?

The following article was adapted from: “Financing Your Business in 2010. 3 rules that have

changed” by Joseph Lizio

2009 was fraught with disaster for most businesses; from the financial crisis making access to

capital nearly non-existent to the recession that significantly curbed consumer spending – both of

which detrimentally hurt the cash flow of nearly every business (small and large) on this planet.

But, as we look back on a very unfavourable year for business financing, there are some lessons

that can be learned as we move forward.

Lesson number 1 - Gone are the days of cheap and fast credit.

No more ‘no doc’ or ‘stated income’ loans. No longer will lenders look the other way for borrowers

with bad credit. Gone are bank financing options for all but the strongest of businesses.

The bottom line is that money is not flowing freely. In fact, it is hardly flowing at all and will continue

that way through 2010; regardless of all the bailouts, recovery acts or pleas from the US

government to open bank vaults again.

But, there are also many ways to finance a start up or growing business. While bank funds are

barely trickling out the door, non-bank financing companies are picking up some of the slack. But,

these products, not usually governed by banking rules, have their own distinct requirements that

must be understood before applying for them.

Further, all of the numerous ways that creative entrepreneurs have found to bootstrap their

business financially in the past will come back into vogue. Thus, business owners will have to rely

on the value of their personal assets just as much as the value of their business assets in obtaining

growth capital in 2010.

Lesson Number 2 - New regulations, designed to protect borrowers, also hurt banks if they

increase their own portfolio risks.

Under new US regulations, the government can come in and take over the bank(s); something

that no bank will put itself in just to underwrite a few subprime business loans.

Banks and many other lenders are stating that they want to lend to businesses but are just not

seeing credit-worthy borrowers; which is in part understandable given high unemployment, lower

income levels and declining personal credit scores.

Banks and other financial institutions rely on both credit scores (the willingness of borrowers to

repay obligations) and cash flow or income (the ability to repay these debt obligations) to make

their loan decisions. Fall short on either of these and the risk to the lender increases significantly.


Lesson number 3 - Banks are now dusting off their lending policies and sticking to them

word for word.

This means not only higher credit standards but specific use of funds requirements, overabundant

collateral values, and the dreaded personal guarantees will all now be required; regardless of how

strong you think your business is on its own.

For business owners seeking capital, this means that, as borrowers, it is no longer sufficient to

just go to your bank and apply for a loan or credit hoping that the bank will tweak its policies to fit

the business’s need.

2010 will require borrowers to better understand, not only the types of loans or capital that may

be available to them, but to understand the rules in which to obtain this credit.

Once these new rules are understood, the business owners will be tasked to execute their

business to fit these new rules – meaning that the business must tweak itself and not rely on the

banks to change their own policies for the business’s benefit.

First, business borrowers must understand what is available given the strength or stage of their

business. Most financial institutions will not fund start-up businesses. But, just because your

business is considered a start-up business doesn’t mean that business credit is out of your grasp.

There are many other financing products for new businesses that do not follow traditional bank

rules. The goal here is to use what is available to build the business to the point that it fits in with

these new banking rules.

Second, regardless of which direction your business takes, if it plans on seeking financing in 2010,

it will start with your credit – the business owner’s personal credit. Bad or poor credit histories will

result in automatic declines – no ifs, ands or buts. Additionally, especially given the myriad number

of defaults and rising bankruptcies from last year, income will be priority in all loan decisions. If

you or your business can’t show (at time of application) enough income to service the loan

payments – it will result in an automatic decline.

The bottom line is the rules of business financing have changed. Even though your business,

from your perspective, may fit a certain product or you may just simply want a certain product – if

you don’t understand these new rules of financing, you will be left in the dark to ultimately fail as

the banks and other lenders are just no longer willing to take the risk.


MANAGEMENT AND FINANCIAL ACCOUNTING

Figure 2 - Management and Financial Accounting

What happens if you do not keep your accounting system up to date?

Chaos, losses, shortages, etc., etc!

Accounting is the system for keeping the records [books] of all the money you collect and all the

money that you spend.

Books have to be properly kept for four reasons:

1. To make sure that you can understand exactly what has happened to the business’s

money.

2. To help you to make realistic plans of what the business can spend and to monitor how

the spending compares with the budget.

3. For accountability and transparency – you should be able to show how every cent was

spent.

4. For security to avoid losing money to mismanagement, corruption or theft.

Management Accounting is concerned with the preparation of accounts so that you can

manage the business more effectively. Management accounts are produced regularly, e.g.

weekly, monthly or quarterly depending on the business and are structured so that they present

the critical information required to manage the business effectively.

MANAGEMENT ACCOUNTING

Planning Planning Planning

Planning

Planning Planning

Planning

Management

action

Reports

Business

activity

Planning

Planning

Planning

Feedback and

Corrective action

MANAGEMENT ACCOUNTING

Actual Actual


Management accounts will provide information on recent historical data and will usually

compare actual figures to forecasted or budgeted figures for the year to date. This gives you

instant feedback on the actual performance of the business versus budgeted or forecasted

performance and allows corrective action to be taken if necessary.

It is impossible to prepare statements if you do not have a clear and accurate bookkeeping

system. A good bookkeeping system depends on proof. It is important that you keep every piece

of paper connected with money that is spent or collected.

Every financial transaction goes through the following steps:

1. The transaction happens when the money is spent or received.

2. The transaction is recorded on a piece of paper as proof that it happened – usually a

receipt issued by you for money you receive or a receipt issued to you by the supplier you

pay for something.

3. The transaction is then recorded in an accounting book – for example a cash book for all

money spent.

4. A summary is made of all transactions and written in a monthly statement.

5. A summary of the transactions for the year is written in an annual statement.

To keep accurate books you should have the following;

A bank account with a cheque book.

A daily record system with receipts and petty cash vouchers.

A monthly record system with a petty cash book and a cash book for recording and

analysing income and expenditure.

A format for annual financial statements, like the Income Statement and Balance Sheet.

4.2 COMPILING AN ACCOUNTS SYSTEM FOR THE BUSINESS

The Accounts function will typically involve the following and data will need to be recorded and

managed for all of these:

1. Credit Purchases.

Recording the data.

Analysing the

transactions.

Interpreting the data.

2. Credit Sales.

3. Cash Sales (if any).

4. Receipts from Customers.

5. Payments to Suppliers.

6. Petty cash purchases and reimbursement.


Recording the data will involve recording the necessary information on each transaction such

as date, type (one of those above), person/company and amount. The recording of this data

will either take place on manual books of account, computerised spreadsheets or entered onto

an accounting software package.

Accounting Process

Figure 3 - Accounting Process

4.3 INTERPRETING THE DATA

Purchases: Are stocks for resale costs running ahead of sales-is there too much stock

ordered or not enough?

Sales: What are the current sales to date/this month and what does this say about the

business?

Receipts: Are there customers with large accounts outstanding or a long time overdue?

Payments: Have creditors being paid ahead of agreed terms or is there payment overdue

on any item, such as VAT*, for example?

The completing of the above areas within accounts should allow for the production of

regular accounts for the business.

*Value Added Tax (VAT) was introduced in South Africa on 30 September 1991 at a rate of 10

per cent. It was increased to 14 per cent on 7 April 1993. Conditions and procedures are laid out

in the Value Added Tax Act No. 89 of 1991. VAT is an indirect, multi-stage method of tax collection

which results in the tax burden ultimately being borne by the final consumer and is levied on the

value added to the product by the vendor.

SOURCE DOCUMENT

SALES JOURNAL

CASHBOOK

PURCHASE JOURNAL

STANDARD JOURNAL

GENERAL LEDGER

TRIAL BALANCE MANAGEMENT

BUDGET ACCOUNTS

CASH FLOW

BALANCE SHEET

INCOME STATEMENT VARIANCE REPORTS

PERFORMANCE REPORTS

FINANCIAL ACCOUNTS

ACCOUNTING PROCESS


Each vendor pays tax on his purchases (input tax) and collects tax on his sales (output tax); that

is, he credits or deducts input tax paid from output tax received. At the end of each tax period, the

vendor is obliged to submit a return accounting for all tax to the Receiver of Revenue. Where

input tax exceeds output tax, the vendor is entitled to a refund of the excess.

All vendors who have turnover of R1 000 000 or more per year MUST register for VAT.

Turnover Tax

Turnover Tax is a simple tax that was introduced for small businesses. The objective is to reduce

the tax compliance and administrative burden by simplifying and reducing the number of returns

that have to be filed.

A typical business may currently be liable for submitting the following to SARS:

1. Value-Added Tax (VAT).

2. Income Tax.

3. Provisional Tax.

4. Capital Gains Tax (CGT).

5. Secondary Tax on Companies (STC).

The simplified tax system will replace all these taxes with a simple Turnover Tax for small

businesses i.e. businesses with a turnover not exceeding R1 million per annum and who meet all

the criteria. New businesses must apply for registration for Turnover Tax within two months of

commencing business activities.

All businesses must prepare accounts once a year. Limited companies are required by law and

sole proprietors will need to do so to calculate the year’s tax liability. However a year is far too

long to wait to look the financial performance of the business. With all businesses there is a need

to produce regular accounts. A simple Income statement would suffice on at least a quarterly, if

not monthly, basis. Financial analysis starts with accounting. Accounting is a service-based

profession that provides reliable and relevant financial information for making decisions.

Accounting is the method in which financial information is gathered, processed and summarised

into financial statements and reports. An accounting system can be represented by the following

graphic:

Figure 4 - Accounting System


Although accountants apply generally accepted accounting principles, there is room for variation

among different businesses (and among different accountants) in the application of GAAP.

Consistency is generally required within a particular business. However, different policies in

different businesses can affect their reported results and distort the picture of where your

business stands in relation to other businesses.

In this regard, consider that:

The time at which sales show up on an income statement may differ from business to

business. A more aggressive approach may accelerate income items by reporting them

at the earliest possible moment, while a more conservative approach may postpone

revenues.

Depreciation charges for financial reporting purposes on essentially similar assets can

differ from business to business, depending on accounting policies with regard to

depreciation methods and useful lives.

Inventory accounting policies may differ. A business using first-in, first-out (FIFO)

accounting (meaning that the oldest inventory items are recorded as sold first.) will show

higher profits in a period of rising prices than will a business using last-in, first-out (LIFO)

accounting (meaning that the most recently purchased items are recorded as sold first).

Policies may differ in regard to expensing. One business may charge an item to income

immediately as an expense, while another business may capitalise the same item and

report a higher profit.

Different methods of treating the cost of developing a product will affect the cost of goods

sold and affect the gross profit reported.

Extraordinary or non-recurring charges may or may not be reflected in operating income,

depending on your accounting policies.

The treatment of tax items may vary from one business to the next.

For all these reasons, when you're comparing your financial statements to industry standards or

to those of another business, take the results with a pinch of salt.


4.3.1 Accounting Equation

Figure 5 - Accounting Equation

4.4 STATUTORY REGULATIONS

4.4.1 Accounting Records

In terms of the Companies Act, all companies must keep accounting records in one of the eleven

offices:

The assets and liabilities of the company,

A fixed-assets register,

Cash receipts and payments,

Details of goods purchased and sold and

Annual stock-taking (inventory) statements.

The accounting records must be such as to fairly present the state of affairs and business of the

company and explain the transactions and financial position of the trade or business of the

company.

4.4.2 Annual Financial Statements

In terms of the Companies Act, the directors of every company must prepare annual financial

statements and present them to the annual general meeting of the company. At a minimum, the

annual financial statements must consist of:

A balance sheet and notes.

An income statement and notes.

Cost of Sales 809 000 Sales 1 000 000 Land and buildings 400 000 Long-term loan 60 000Interest Expense 500 Rent income 40 000 Machinery 40 000 Mortgage loan 350 000Interest on load 37 000 Interest income 1 000 Equipment 30 000Settlement discount granted 1 500 Interest on savings account 500 Furniture 20 000Salaries and wages 15 000 interest on fixed deposit 1 000 Vehicles 120 000Insurance 10 000 Settlement discount received 500 Fixed deposit 10 000Repairs and maintenance 1 000 Commission received 2 500Advertising 2 500Postage 1 500 Trading inventory (stock)50 000 Short-term loans 30 000Telephone 4 500 Debtors 40 000 Creditors 15 000Fuel 14 000 Savings account 10 000 Bank overdraft 5 000Packing Materials 9 000 Petty cash 3 000 VAT output 2 000Stationery 3 500 Cash float 2 000Office consumables 2 500 VAT input 1 000

CURRENT ASSETS (106 000) CURRENT LIABILITIES (52 000)

LIABILITIES (462 000)

NON-CURRENT LIABILITIES (410 000)NON-CURRENT ASSETS (620 000)

ASSETS (726 000)

INCOME (1 045 500)

CAPITAL (250 000)DRAWINGS (120 000)

EXPENSES (911 500)

OWNERS'S EQUITY (264 000)


A directors' report.

An auditors' report; and

A cash flow statement.

The annual financial statements must fairly present the state of affairs of the company as at the

financial year-end and its profit or loss for that year in conformity with generally accepted

accounting practice (GAAP). If a company has subsidiaries at the end of its financial year and is

not a wholly-owned subsidiary of another company incorporated in South Africa, it has an

obligation to prepare group financial statements.

Every company that is not a wholly-owned subsidiary of another company incorporated in South

Africa must submit a directors' report, which must cover such matters as:

The state of affairs of the company.

A description of the company's business.

The profit or loss of the company and its subsidiaries.

Any material matters in any of these areas and certain other matters specifically identified in

applicable legislation must be addressed in the directors' report.

4.4.3 Interim Reports

Public companies and branches of foreign companies (external companies) are required to send

all members and debenture holders a half-yearly interim report, fairly presenting the business and

operations of the company (or, if applicable, the group). It is not required that such interim reports

be audited, but they must be approved by the directors and signed on their behalf by two of the

directors.

Private companies are not required to provide an interim report to members.

4.4.4 Provisional Financial Statements

If a public company has not issued annual financial statements within three months after its year-

end, it must (within such three-month period) issue provisional financial statements to its members

and debenture-holders. These must fairly present the business and operations of the company

or, if applicable, the group. The requirements for private companies are less stringent.

If a private company has not issued its financial statements within six months after its year-end,

the Companies and Intellectual Property Registration Office (CIPRO - formerly the Registrar of

Companies) may, on application by a member and for good cause shown, require that provisional

financial statements be submitted to that member. It is not necessary that such provisional annual

financial statements be audited but they must be approved and signed by the company's directors.


4.4.5 Close Corporations (CCs)

For a close corporation, the requirements relating to the maintenance of accounting records are

similar to those for a company. A close corporation's annual financial statements must be drafted

within nine months after its year-end. The annual financial statements must be approved and

signed by or on behalf of members holding at least 51% of the members' interest in the close

corporation and must consist of:

A balance sheet and notes.

An income statement or any similar financial statement (if such alternative is appropriate).

A members' net investment statement.

The financial statements must fairly present the state of affairs and the result of the operations of

the close corporation, in conformity with GAAP as appropriate to the business of the close

corporation.

4.4.6 Annual Audit Requirement

The financial statements of both public and private companies are subject under the Companies

Act to an annual audit. Only chartered accountants registered with the Public Accountants and

Auditors Board may be appointed as auditors for the purposes of the annual audit.

Close corporations are not subject to a compulsory audit. However, the corporation is required to

appoint an independent accounting officer, who is responsible for the preparation of the financial

statements and who must be a member of one of the recognised professional accounting bodies.

4.4.7 Filing and Disclosure Requirements

Copies of a company's annual financial statements and group annual financial statements (if any)

must be sent to the shareholders and debenture holders of the company not less than twenty-

one days before the date of the company's annual general meeting.

Public companies and external companies are required to file a copy of their annual financial

statements with the Companies and Intellectual Property Registration Office within six months

from the end of their financial year.

Private companies are not required to do so, although the Second King Report on Corporate

Governance has recommended that the Companies Act be amended to require this. An external

company must also file a copy of its annual financial statements as prepared in terms of the

requirements of the jurisdiction in which it is incorporated. External companies can apply for

exemption from this and other requirements and such exemption is fairly readily granted.

The disclosure requirements for a close corporation are not as stringent as those for a company

and are subject to the overriding requirement of fair presentation. The complexity of the financial

statements would depend on the needs of the members, who, as owners and managers of the

corporation, are the primary recipients of the financial information.


4.4.8 Form and Content of Financial Statements

The Companies Act does not require a company to specify how its net profit for the year is made

up, but does require certain items of income and expenditure to be detailed, for example turnover,

depreciation, directors' remuneration, interest paid and provision for taxation.

If a company or group is involved in more than one type of business, the directors' report must

indicate the proportion of profit attributable to each type of business. Notes to the financial

statements usually provide details of all significant items shown on the balance sheet.

In addition to the Companies Act requirements, GAAP requires the disclosure of information

concerning the company's accounting policies, details of taxation, extraordinary items, prior-year

adjustments in the income statement and other matters. Additional disclosure requirements apply

to companies listed on the JSE. These requirements call for the disclosure of directors' interests

in the share capital of the company, employee share incentive schemes and borrowing powers

and also require interim and preliminary reports to the members. The King II Report on Corporate

Governance also recommended disclosure of directors' remuneration and benefits on an

individual basis.

Under the Close Corporations Act, a close corporation's accounting officer is required to ensure

that the annual financial statements accord with the books and records of the corporation.

Do I know what is going on in my company finances or do I leave the

details to my bookkeeper/accountant?

As a small business, do I qualify for Turnover Tax?

What are the advantages and disadvantages of registering for

Turnover Tax?

MEASUREMENT: CASH FLOW 29

5. MEASUREMENT: CASH FLOW

5.1 WHAT IS CASH FLOW?

Business is all about trade, the exchange of value between two or more parties, and cash is the

asset needed for participation in the economic system. For this reason - while some industries

are more cash intensive than others - no business can survive in the long run without generating

positive cash flow per share for its shareholders. To have a positive cash flow, the company's

long-term cash inflows need to exceed its long-term cash outflows.

An outflow of cash occurs when a company transfers funds to another party (either physically

or electronically). Such a transfer could be made to pay for employees, suppliers and creditors,

or to purchase long-term assets and investments, or even pay for legal expenses and lawsuit

settlements.

It is important to note that legal transfers of value through debt - a purchase made on credit - is

not recorded as a cash outflow until the money actually leaves the company's hands.

A cash inflow is the exact opposite; it is any transfer of money that comes into the company's

possession. Typically, the majority of a company's cash inflows are from customers, lenders (such

as banks or bondholders) and investors who purchase company equity from the company.

Occasionally cash flows come from sources like legal settlements or the sale of company real

estate or equipment.

5.2 WHAT IS THE DIFFERENCE BETWEEN CASH FLOW AND INCOME?

It is important to note the distinction between being profitable and having positive cash flow

transactions: just because a company is bringing in cash does not mean it is making a profit (and

vice versa).

For example, say a manufacturing company is experiencing low product demand and therefore

decides to sell off half its factory equipment at liquidation prices. It will receive cash from the buyer

for the used equipment, but the manufacturing company is definitely losing money on the sale: it

would prefer to use the equipment to manufacture products and earn an operating profit.

But since it cannot, the next best option is to sell off the equipment at prices much lower than the

company paid for it. In the year that it sold the equipment, the company would end up with a

strong positive cash flow, but its current and future earnings potential would be fairly bleak.

Because cash flow can be positive, while profitability is negative, one should analyse income

statements as well as cash flow statements, not just one or the other to get a true picture of the

company’s state of health.


5.3 WHAT IS THE CASH FLOW STATEMENT?

We have already said that there are three important parts of a company's financial statements:

1. The balance sheet,

2. The income statement and

3. The cash flow statement.

We will learn more about the balance sheet and income statement later, but for now we can say

that the balance sheet gives a one-time snapshot of a company's assets and liabilities, while the

income statement indicates the business's profitability during a certain period.

The cash flow statement differs from these other financial statements because it acts as a kind of

corporate cheque book that reconciles the other two statements.

Simply put, the cash flow statement records the company's cash transactions (the inflows and

outflows) during the given period.

It shows whether all the revenues booked on the income statement have actually been collected.

At the same time, however, remember that the cash flow does not necessarily show all the

company's expenses: not all expenses the company accrues have to be paid right away. So even

though the company may have incurred liabilities it must eventually pay, expenses are not

recorded as a cash outflow until they are paid.

In short, the cash flow statement records the amounts of cash and equivalents entering and

leaving a company. It shows how a company's operations are running, where its money is coming

from, and how it is being spent.

Kyosaki Model:

Figure 6 - Kyosaki Model with inclusion


5.4 IMPLICATIONS OF CASH FLOW FOR THE BUSINESS OWNER

If the business owner is able to compile a cash flow projection for the business, s/he is better

equipped to deal with cash shortfalls as and when they arise.

By looking into the future, you can estimate how many sales the business is expected to make,

what other sources of income there may be, as well as which proportion of the sales will be cash

sales and which will be credit sales. You will also know which payments have to be made and

when they are due.

You will therefore be able to predict the flow of cash for the coming months and pro-actively

determine potential areas of shortfall, thus enabling you to make appropriate arrangements, such

as extra short-term financing from the bank, or encouraging debtors to pay on time.

5.5 UNDERSTANDING THE CASH FLOW STATEMENT

The cashflow statement is discussed on the next page:

Cash Flow Statement

Company ABC

FY Ended 31 December 2009

Cash flow from operations

Net earnings 2 000 000

Additions to Cash

Depreciation 10 000

Decrease in Accounts Receivable 15 000

Increase in Taxes Payable 2 000

Subtractions from Cash

Decrease in Accounts Payable - 15 000

Increase in Inventory - 30 000

Net Cash from Operations

Cash Flow from Investing

1 982 000

Equipment - 500 00

Cash Flow from Financing

Notes Payable 10 000

Cash Flow from FY Ended 31 Dec 2009 1 492 000

The following is a list of the various areas of the cash flow statement above and what they mean:

Cash Flow from operating activities - This section measures the cash used or provided

by a company's normal operations. It shows the company's ability to generate consistently

positive cash flow from operations. Think of "normal operations" as the core business of

the company. For example, Microsoft's normal operating activity is selling software.


Cash Flow from investing activities - This area lists all the cash used or provided by

the purchase and sale of income-producing assets. For example, if Microsoft bought or

sold companies for a profit or loss, the resulting figures would be included in this section

of the cash flow statement.

Cash Flow from financing activities - This section measures the flow of cash between a

firm and its owners and creditors. Negative numbers can mean the company is servicing

debt, but can also mean the company is making dividend payments and stock

repurchases, which investors might be glad to see.

From the cash flow statement above, we can see that the cash flow for the 2009 financial year

(FY) was R1 492 000. The bulk of the positive cash flow stems from cash earned from operations,

which is a good sign for investors. It means that core operations are generating business and that

there is enough money to buy new inventory.

The purchasing of new equipment shows that the company has cash to invest in inventory for

growth. Finally, the amount of cash available to the company should ease investors' minds

regarding the notes payable, as cash is plentiful to cover that future loan expense.

Of course, not all cash flow statements look this healthy, exhibiting a positive cash flow. But a

negative cash flow should not automatically raise a red flag without some further analysis.

Sometimes, a negative cash flow is a result of a company's decision to expand its business at a

certain point in time, which in fact would be a good thing for the future.

This is why analysing changes in cash flow from one period to the next gives the owner a better

idea of how the company is performing, and whether or not a company may be on the brink of

bankruptcy or success.

Profit and Loss Analysis

Figure 7 - Profit and Loss Analysis

10% 15% 20% 25% 30% 35% 40%

Discount

2% 25% 15% 11% 9% 7% 6% 5%

3% 43% 25% 18% 14% 11% 9% 8%

4% 67% 36% 25% 19% 15% 13% 11%

5% 100% 50% 33% 25% 20% 17% 14%

7.5% 300% 100% 60% 43% 33% 27% 23%

10% 200% 100% 67% 50% 40% 33%

15% 300% 150% 100% 75% 60%

Gross Profit Margin Requirement

Increase in volume required to make same Gross Profit


Problems often experienced with cash flow:

1. Sales forecasts are too optimistic.

2. Gross profit potential is not managed properly.

3. High loan interest.

4. Ineffective stock and fixed asset management.

5. Ineffective debtor management.

6. Ineffective creditor management.

7. In the case of business owners, the drawings are too high, usually to support an

extravagant lifestyle.

Generally, a company's principal industry of operation determines what is considered proper

cash flow levels; comparing a company's cash flow against its industry peers is a good way to

gauge the health of its cash flow situation. A company not generating the same amount of cash

as competitors is bound to lose out when times get rough.

Even a company that is shown to be profitable according to accounting standards can go under

if there isn't enough cash on hand to pay bills. Comparing amount of cash generated to

outstanding debt, known as the operating cash flow ratio*, illustrates the company's ability to

service its loans and interest payments. If a slight drop in a company's quarterly cash flow would

jeopardise its loan payments, that company carries more risk than a company with stronger cash

flow levels.

*What Does Operating Cash Flow Ratio Mean?

A measure of how well current liabilities are covered by the cash flow generated from a company's

operations.

Formula:

Unlike reported earnings, cash flow allows little room for manipulation. Every company filing

reports with SARS is required to include a cash flow statement with its quarterly and annual

reports. Unless tainted by outright fraud, this statement tells the whole story of cash flow: either

the company has cash or it doesn't.

Remember, the cash flow statement is simply a piece of the puzzle. So, analysing it together with

the other statements can give you a more overall look at a company's financial health.


5.6 FREEING UP THE CASH IN YOUR BUSINESS

Companies normally focus on sales, expenses and profit, but often neglect cash flow.

Cash flow is not a direct measure of profitability, but companies with good cash flow are usually

profitable. Cash flow is simply a company's ability to turn its products and services into cash.

In order to have good cash flow, you need to manage your company's resources well. Growth in

working capital is a common cause of cash flow problems that, with a little discipline, can be

avoided.

Cash flow, simply stated, is the process of using cash to make cash. The goal is to effectively

manage the cash outlays and maximise the cash in-flow, all within the shortest possible cycle

time.

The following are several best practices for freeing up cash:

1. Get a good grip on distribution expense.

Outside of actual product costs, distribution expense is one of the largest cost components for

most businesses (including costs related to transporting, storing, and delivering products to

customers). In many businesses, distribution costs can exceed 10 percent of gross sales thus

efficient distribution definitely qualifies as a cash flow and revenue enhancement opportunity.

Efficient distribution means that products and services can be delivered to customers faster and

more accurately, so, in turn, cash can be collected faster, thereby increasing the cash-to-cash

cycle. And, in many cases, the ability to get products to customers more efficiently can be a

competitive advantage in the marketplace, providing an opportunity to differentiate your business,

and perhaps to charge a premium.

2. Plan and forecast inventory demand accurately.

This critical function has a significant downstream impact in terms of the amount of working capital

tied up in inventory throughout the year, and the costs to handle and store excess inventory.

When working capital for inventory and receivables grows faster than a company's bottom line, it

can be a significant drain on assets. Many companies have grown themselves into trouble in this

way

It is important to understand, and not exceed, the inventory levels your business needs to

maintain. Volume purchase discounts are not always the right answer.

Weigh the benefits of these discounts against the cost of maintaining the inventory - which

includes interest, warehousing, and insurance costs. Be sure to benchmark inventory turns with

industry peers, and work to maintain 'best practice' levels. There have been instances where one

company found its inventory turned over three times a year, while for others in its industry it was

about one-third less.


To reduce inventory levels, corporate leadership made inventory management a priority - then

tied it to bonuses, to sustain it at optimal levels.

It's also important to be certain of what you have in inventory. So often we've seen companies

that need to make their parts numbers the same at all of their branches, so each one can

understand what inventory it really has. This is often an issue following an acquisition.

When you can't trust your inventory systems, you tend to order in excess to ensure that you can

meet customer demand.

Another key area is the measurement of forecast accuracy. The percentage of a given month's

forecast-versus-actual orders is a key metric. Companies that forecast demand well typically see

an aggregate accuracy of 85 percent, while those that are best in class can achieve up to 95

percent.

While sophisticated planning and forecasting tools are significant enablers in this process,

companies can also achieve improvements just through implementing key business processes,

and discipline. The collaborative planning process should include sales, finance,

operations/procurement functions, and - to the extent possible - customers and vendors. It has

been observed that by focusing initiatives on key functions, generally inventory levels can be

improved by up to 25 percent, revenue growth by up to 15 percent, and forecast accuracy by up

to 30 percent. Also, increasing forecast accuracy by improving processes and discipline tends to

foster better customer service and operating cost reductions.

3. Organise and automate warehouse operations.

Many growing businesses have little or no automation in their warehouse operations, and often

struggle with operational efficiency. Companies may find that warehouse-related costs exceed

three to four percent of total sales.

Simply improving the efficiency with which products are moved from the manufacturing floor to

the warehouse, and to trucks, as customers place orders, can reduce these costs. Organising

warehouse space and improving workflow will lead to an increase in order-fill accuracy - and

significant cost savings by reducing the amount of warehouse space leased, and associated

excess labour - as well as higher levels of customer satisfaction.

Businesses that undertake initiatives to improve warehouse operational efficiency can often

achieve labour reductions of up to 30 percent, and increases in storage utilisation of 20 to 30

percent. In addition, higher accuracy and more satisfied customers tend to speed up the collection

cycle and eliminate the cost of mistakes, such as paying freight on returned goods.

Businesses may also find that by outsourcing the warehousing and distribution function to a third-

party logistics company, they can improve the efficiencies of their operations, and focus on what

they do best.


4. Forecast cash position year round.

It's imperative to forecast your cash position to determine the levels of financing needed to operate

your business. Understand the seasonal nature of your business and how that affects your cash

levels.

This will enable you to identify the type of revolving credit that's best for your company's situation.

5. Manage customer expectations and payments.

Make only delivery promises that you can keep. Satisfied customers tend to pay on time.

Don't leave timely payments to chance, however. Assign someone to call customers and vendors

when payments are just a few days late.

6. Review accounts payable for refunds and credits

Because of the sheer volume of transactions, decentralised processes, and the resource

constraints all too common in today's business environment, even companies that are confident

in their systems will often find refunds and vendor credits due to them, because they are making

duplicate vendor payments, or not taking full advantage of available credits and discounts.

When businesses pursue opportunities to become more efficient, not only do their costs tend to

go down, but also, like a balance scale that pushes one side up as the other goes down, the

business may find it has the ability to increase revenue - for example, by delivering increased

value to the customer through better service, and in so doing differentiating itself from its

competitors.

5.7 CASH FLOW SUMMARY

HOW TO MANAGE CASH FLOW HOW TO COLLECT OUTSTANDING DEBTS

Cash flow is the lifeblood of any business. So you

must implement processes and procedures to ensure

that you get paid on time, every time. Failure to

adhere to these procedures will see your debtors list

grow.

Every organization seems to have errant debtors. And,

although your formal management training might not have

included debt recovery, you can be sure that others will

look to you for guidance and assistance in collecting

outstanding debts. By adapting the following simple

suggestions to your own situation, you will largely satisfy

those expectations.

Agree on a price before work commences

Build a sound relationship with customers

Adopt simple, straightforward procedures

Grab the attention of the debtor

Be persistent

Deal only with authorized bill-payer

Set an example

Reject the myths of debt collecting

Decide if the debt is really worth pursuing

Be persistent

Capture the debtor’s attention

Be prepared to act decisively

Apply an appropriate carrot or stick approach

Think and act creatively

Build up a resource bank


HOW TO SAVE MONEY BY CUTTING COSTS HOW TO AVOID CASH BANKRUPTCY

In tough economic times it is vital for organizations to

minimise running costs without jeopardising the

welfare of employees or the productivity of the

business. By examining some of the fundamental

requirements of your organization – such as

telephones, photocopies, lighting, office supplies and

outside services – you can make considerable

savings. Over a year, these savings can markedly

improve your financial bottom line.

Bankruptcies continue to soar, particularly in small

businesses. Indeed, analysis of why business goes to the

wall have found that up to 90 per cent of organizations

that end in financial ruin made the same mistakes. The

message is that, if your business repeats these mistakes,

you too will walk the same path to financial ruin. So before

it’s too late, consider the following sound advice.

Recycle wherever

Reduce your interior lighting costs

Focus on the photocopier

Limit telephone costs

Minimise expenses professional fees

Seek the advice of your staff

Check productivity

Introduce your cuts imaginatively

Know why businesses fail

Develop and follow a business plan

Ensure you have sufficient capital

Manage your cash flow

Focus on the running of the business

Keep your records up to date

Install appropriate systems

Plan for taxation especially VAT

Focus on profit, not survival

Know your break-even point

Manage your resources wisely

Control cash flow to the shortest possible period (month or week)

Budget for cash flow

Pay yourself a salary

COST MANAGEMENT 38

6. COST MANAGEMENT

Cost management is the process of planning and controlling the budget of a business. Cost

management is a form of management accounting that allows a business to predict impending

expenditures to help reduce the chance of going over budget. Businesses use cost control

methods to monitor, evaluate, and ultimately enhance the efficiency of specific areas, such as

departments, divisions, or product lines, within their operations.

Many businesses employ cost management plans for specific projects, as well as for the over-all

business model. When applying it to a project, expected costs are calculated while the project is

still in the planning period and are approved beforehand. During the project, all expenses are

recorded and monitored to make sure they stay in line with the cost management plan. After the

project is finished, the predicted costs and actual costs can be compared and analyzed, helping

future cost management predictions and budgets.

Integrated Project Control and Change Management Flow

Figure 8 - Project Control and Change Management Flow

Cost control is a continuous process that begins with the proposed annual budget.

The budget helps:

1. to organize and coordinate production, and the selling, distribution, service, and

administrative functions; and

2. to take maximum advantage of available opportunities. As the fiscal year progresses,

management compares actual results with those projected in the budget and incorporates

into the new plan the lessons learned from its evaluation of current operations.

COST MANAGEMENT 39

Control refers to management's effort to influence the actions of individuals who are responsible

for performing tasks, incurring costs, and generating revenues. Management is a two-phased

process: planning refers to the way that management plans and wants people to perform, while

control refers to the procedures employed to determine whether actual performance complies

with these plans. Through the budget process and accounting control, management establishes

overall company objectives, defines the centers of responsibility, determines specific objectives

for each responsibility center, and designs procedures and standards for reporting and evaluation.

A budget also sets standards to indicate the level of activity expected from each responsible

person or decision unit, and the amount of resources that a responsible party should use in

achieving that level of activity. A budget establishes the responsibility center, delegates the

concomitant responsibilities, and determines the decision points within an organization.

The planning process provides for two types of control mechanisms:

1. Feed forward: providing a basis for control at the point of action (the decision point); and

2. Feed back: providing a basis for measuring the effectiveness of control after

implementation.

Management's role is to feed forward a futuristic vision of where the company is going and how it

is to get there, and to make clear decisions coordinating and directing employee activities.

Management also oversees the development of procedures to collect, record, and evaluate

feedback. Therefore, effective management controls results from leading people by force of

personality and through persuasion; providing and maintaining proper training, planning, and

resources; and improving quality and results through evaluation and feedback.

6.1 CONTROL REPORTS

Control reports are informational reports that tell management about an entity's activities.

Management requests control reports only for internal use, and, therefore, directs the accounting

department to develop tailor-made reporting formats. Accounting provides management with a

format designed to detect variations that need investigating.

In addition, management also refers to conventional reports such as the income statement and

funds statement, and external reports on the general economy and the specific industry.

Control reports, then, need to provide an adequate amount of information so that management

may determine the reasons for any cost variances from the original budget. A good control report

highlights significant information by focusing management's attention on those items in which

actual performance significantly differs from the standard.

Managers perform effectively when they attain the goals and objectives set by the budget.

With respect to profits, managers succeed by the degree to which revenues continually exceed

expenses. In applying the following simple formula, managers, especially those in operations,

realize that they exercise more control over expenses than they do over revenue.

COST MANAGEMENT 40

While they cannot predict the timing and volume of actual sales, they can determine the utilization

rate of most of their resources, that is, they can influence the cost side. Hence, the evaluation of

management's performance and its operations is cost control.

Standards

Figure 9 - Standards

6.2 COST CUTTING FOR SMALL BUSINESSES

A variety of techniques can be employed to help a small business cut its costs. One method of

cost reduction available to small businesses is hiring an outside analyst or consultant. These

individuals may be independent consultants or accountants who analyze costs as a special

service to their clients. They generally undertake an in-depth, objective review of a company's

expenditures and make recommendations about where costs can be better controlled or reduced.

Some expense-reduction analysts charge a basic, up-front fee, while others collect a percentage

of the savings that accrue to the company as a result of their work. Still others contract with

specific vendors and then pool the orders of their client companies to obtain a discount.

Some of the potential benefits of using a consultant include saving time for the small business

owner, raising awareness of costs in the company, and negotiating more favourable contracts

with vendors and suppliers.

Steps that a small business can take relatively quickly and can start them down the path of cost

reduction include such things as printing or photocopying on both sides of the paper whenever

possible. Securing supplies to which employees have access, like locking the office supply

cabinet, to better track usage of these items. Cancelling insurance policies on unused equipment

and vehicles is another way to check unnecessary costs.

COST MANAGEMENT 41

Establishing a regular cost-cutting program can be done by setting aside time to review several

months' worth of checks and invoices and make a detailed list of all monthly expenses.

Then, decide upon a few areas that might benefit from comparison-shopping for better prices. If

the small business owner is not inclined to undertake the comparison-shopping personally, a

responsible employee can be assigned to the task.

Despite the importance of cost control to small businesses, and the potential for cost savings,

cost reduction alone cannot guarantee success. For cost cutting to be effective, the sales and

revenue end of the business must be healthy. "Only the most exceptional leaders of the most

exceptional companies avoid getting sucked into a period of heady growth followed by desperate

cutbacks," Alan Mitchell wrote in Management Today. "These companies have learned the hard

way that cost cutting alone doesn't guarantee customer preference."

Mitchell went on to explain that every business reaches a point in its growth when management

recognizes a need to cut costs, usually in the face of a crisis. "Over time, you get a cost cutting

culture," consultant Paul Taffinder told Mitchell. "Once you have, the types of people who are

good at building things—creating new values, new products, new services—are driven out of the

business because it is unpleasant for them to work there. Then, once boom time arrives again,

the organization piles on capacity but doesn't solve the problem of creating innovative potential.

It has to hire talented new people again." Many companies repeat this process of inefficient growth

several times.

The effective implementation of a cost control and reduction program takes planning and time. It

should be seen as a continuous process and one that will need ongoing attention. Instead of

blindly trying to cut costs in the face of a crisis, Mitchell recommended that managers embrace

cost cutting as a strategic issue and approach the task from a marketing perspective. "If you are

going to talk about waste, you need to define what value is, because the opposite of waste is

value," business school professor Dan Jones told Mitchell. "And you can only define value from

the end customer's perspective. If you can really do this—if you really know what it is that doesn't

add value to the customer—then you can start asking 'How can we get rid of that?' Otherwise, we

are just saying 'Let's cut costs."

Figure 10 - Cost Control

COST MANAGEMENT 42

5 Ways to Control Corporate Control

1. Renegotiate all contracts annually. For whatever reason, South African businesses

presume that multiple year contracts will result in lower costs. May be sometimes, but not

always. A smart company policy is not to have the life of a contract exceed one year. This

forces annual bidding or at least renewal discussions with the current suppliers. Almost

always these discussions will result in lower cost of goods. A multi-year contract will

usually favor the vendor. Of course this is a lot of work. But it sure pays out.

2. Ask your customers. Annual planning sessions with customers have many

benefits. Naturally these discussions primarily should focus on ways to grow the

business. But too often these discussions fail to address costs. By discussing costs

holistically up and down the combined supply chains, customers often can recommend

ways to reduce costs. For example, how to take wasted steps out of the process, or how

to plan jointly to smooth production, or maybe even how to change the product mix to get

rid of costly items and replace them with some that are more profitable. Talking to the

customer is never a bad thing. But talking about how to jointly improve business deepens

the relationship, shows them you care, and helps reduce costs for both parties.

3. Match terms with turns. Each item in your inventory moves at a different rate. And yet

suppliers normally apply a one-size-fits-all approach to payment terms. You can reduce

your working capital to zero if payment terms were matched with the inventory turns of

each item. By negotiating this into your contracts it incents the suppliers only to sell the

best moving items and to work with you to improve inventory productivity. The results will

free up cash that can be deployed elsewhere in the business and improve profits.

4. Ask vendors to own “their” inventory. Better even than matching terms with turns is to

have the vendors keep title to their inventory until sold.

5. Normally inventory acquired from a vendor is held in your warehouse for use in

manufacturing conversion or resale to your customers. But why think of it as your

inventory? It hasn’t been used yet so why isn’t it their inventory? Best planning results in

“just-in-time” delivery so there is no inventory. But this isn’t always possible, for instance,

in industries like retail where that inventory is necessary for your own customers. But

again, why are you paying them and then sitting on their inventory? They need to own

the inventory until time of sale. This is commonly referred to as “scan based trading” or

“just-in-time trading.”

6. Hold headcount constant. For sure this is a blunt instrument and it won’t always

work. But…. A long time ago I worked with a founder of a business we acquired. I

complained one day that the parking lot was too tight and we needed to expand. He

smiled and told me he knew exactly how many spots were in the lot and checked the

number of cars regularly. When parking became too tight he knew his headcount had

become bloated and he needed to take action. While this isn’t the best or even a practical

way to track headcount for most businesses, the lesson still is poignant. Efficiency

is gained when revenue per employee grows. Technology, lean techniques, process

engineering, etc. all are tools to free up time so employees can become more productive

and you don’t have to add new headcount to grow. What if you could replace your lowest

10% of performers with new people that matched your top 10%?

COST MANAGEMENT 43

This would result in a huge productivity boost at virtually no incremental cost. There are

a lot of techniques to improve productivity, but the point is that constantly growing

headcount certainly will result in overhead growth but won’t necessarily result in profitable

revenue growth.

Tips for cutting costs and keeping spending down:

1. Aim for zero cost at all times

How much can you get for free? Get office furniture by picking it up on Freecycle or the ‘free stuff’

section on Gumtree. Barter goods and services with other businesses. Look around the net for

free versions of software you usually have to pay for. See if big companies you deal with could

sponsor your activities by giving goods in return for promotion from you.

2. Outsource where possible

Every staff member is a high cost, whatever actual salary you pay them. Where possible use

freelancers and outside companies for functions such as IT, publicity, accountancy and even

administration. Timothy Ferris, author of "The 4-Hour Work Week" suggests you hire "virtual

assistants" from Internet companies like Your Man in India and AskSunday who, for R4 to R25

an hour, will perform all your admin tasks and more.

3. Get into remote working

On a similar note, seriously look at ditching the office for working from home and contacting your

team through Skype, email and instant messaging. Occasionally hire an office for a day or two

through a temporary office rental company.

4. Keep a daily eye on money coming in and going out

You don’t have to be your own bookkeeper but you do need to know, to the penny if necessary,

what money is coming in and, particularly, going out each day. Question all spending and get

others in your team - particularly your accountant - to question your spending even further.

5. Shop around for cheaper versions of everything at least once a year

Look into switching your phone system to VoIP technology, use a comparison service like

Makeitcheaper.com to get cut-price gas and electricity, haggle on all insurance, get rid of cleaners

and make it a job you and your team do. Whatever you spend, try and get it for less!

https://www.yourmaninindia.com/

http://www.asksunday.com/

http://www.makeitcheaper.com/

COST MANAGEMENT 44

6. 2Steps to implement a Cost Control System

1. Investigate and understand the types of costs incurred by the organisation.

2. Communicate the need for cost consciousness to all employees.

3. Motivate employees through education and incentives.

4. Compare actual results to budgets and analyse for future methods of improvement.

5. View cost control as a long-run process, not a short-term solution.

Employing good records management practices has a positive impact on your office's bottom line.

Records management and Records Management Services (RMS) can help.

The efficient management of records lowers the cost of doing business.

7. Promoting Efficiency

1. Records management enables Harvard to administer its resources and information more

efficiently by reducing the amount of duplication, costly errors, and the amount of time and

productivity lost searching for or recreating information. Records management and

Records Management Services (RMS) can help you to:

2. Save time - it's estimated that in a typical organization, at least 20% of staff time is spent

looking for information. Computer users spend 7.5% of their time on a PC looking for

misplaced files. Good records management enables information and records to be

retrieved quickly and reliably, thus reducing this time considerably.

3. Increased employee productivity - when there is a glut of unmanaged records and

information, it is difficult for employees to locate the information that they need to do their

jobs and to take advantage of the content and intellectual property that may already exist

in the office. With proper records management, information is more easily and effectively

located, retrieved, and re-used.

4. Optimize prime office space - better utilize limited office space by reducing unnecessary

records, particularly duplicates and records beyond their retention period, and expensive

on-site equipment such as filing cabinets, freeing up office space for people and other

uses.

5. Improve capacity to collaborate and share information - good organization and

management of records allows for easy access to information and facilitates the sharing

of information.

6. Support decision making - establishing records management controls improves the

reliability and availability of crucial information so that staff have information they need to

make decisions in a timely manner. Access to the collective memory of the office also

provides precedents for actions, and should prevent the need to 're-invent the wheel.'

2 www.accounting-financial-tax.com

COST MANAGEMENT 45

6.3 PETTY CASH – THE SMALL ANTS IN YOUR ORGANISATION

Petty cash funds often run out. To determine how much to keep in the fund, check last year's

replenishments.

Have no petty cash at all!

Summary

A well-run petty cash fund includes:

set Rand limits on petty cash disbursements;

reimbursement limits based on type of outlay;

reimbursements only for valid business expenses;

restriction of petty cash only to certain employees;

lists of reimbursable miscellaneous expenses;

requiring completed, sequentially numbered vouchers to account for each disbursement;

requiring receipts for all vouchers when possible;

periodic reconciliation of cash and vouchers;

prohibition of disbursements for personal checks;

distribution of petty cash policies to employees.

Effects Caused by Not Implementing Cost Control

1. Over Budget

Any project with no cost control measures in place is at risk of running over budget. The knock-

on effects of this could be disastrous. Perhaps you will run out of funds to complete the project,

thus wasting your initial investment. Perhaps you will have to borrow additional money, adding

greatly to your interest costs. You could fail to hit deadlines and lose major clients.

2. Missing Savings

In addition to going over budget, you may miss opportunities for your business to save money. It

could be that there are lower cost suppliers for certain parts or services that you could be using.

It might be that your production process is prone to wasteful mistakes or inefficiencies. You could

be carrying too much inventory, or shipping in a costly way.

All these things can show up in a properly implemented cost control system and be corrected.

COST MANAGEMENT 46

3. Fraud

If you have no cost controls in place it’s not easy to see where your money is going. If you have

employees or outside contractors who are stealing from you, it becomes much harder to detect

without a proper cost control system. If every Rand and every raw material is logged and

accounted for, it’s much harder for things to go missing without being detected.

4. Reporting

Some projects may rely on external funding, or you may have relied on a credit institution such

as a bank for the cash. In some circumstances, your outside funders will want full reporting and

accountability for the costs of a project.

If you have not implemented cost controls you may be subject to outside penalties, or you simply

may not be able to provide your backers with the paperwork they need to see that your project is

on track.

Control against a zero base

Control through regular budget management accounts

No private expenditure allowed through company financials

No purchases allowed without an official purchase order

INTERPRETATION OF FINANCIAL STATEMENTS 47

7. INTERPRETATION OF FINANCIAL STATEMENTS

Financial statements are used to do financial analysis. Financial statements are accounting

reports prepared periodically to inform the owner, creditors and other interested parties as to the

financial condition and operating results of the business.

7.1 PURPOSE OF FINANCIAL ANALYSIS

The purpose of financial analysis varies in every organisation, but generally it would include:

Determining whether the company has achieved its main objective which is the

maximisation of profit.

Determining whether the company will be able to repay interest and capital on long-term

loans.

Determining whether the company will be able to service its short-term debts from liquid

funds.

Determining whether the company will be able to honour commitments relating to

guarantees supplied.

Establishing if certain investments yield a fair and acceptable return.

Establishing whether the company has the potential to issue further ordinary shares,

preference shares or debentures.

Establishing, if the company is underperforming, what the problem areas are.

Making recommendations in connection with the take-over, reconstruction or

amalgamation of the company.

Evaluating the ability of the company to pay personnel and supply other benefits to

personnel.

7.2 STEPS FOR DOING A FINANCIAL ANALYSIS

To do a financial analysis, the manager needs to establish the purpose of the analysis. Once the

purpose of the analysis has been established, the approach usually follows the typical stages

illustrated on the next page.


Steps to follow:

Figure 11 - Steps to follow for doing a Financial Analysis

Financial analysis is used to fulfil one of the key challenges facing a business - establishing how

well the business is performing. This is also known as a financial health check or viability check

and indicates the business’s sustainability.

The primary financial statements of a company are prepared in order to provide information to

the users of these statements to help them make economic decisions. Such decisions are made

within the context of environmental factors which impact on the company.

The analysis of financial statements must therefore be conducted with insight into the expected

economic conditions which will prevail in the industry and economy.

The main considerations in every analysis are:

To establish the purpose of the analysis that needs to be done. Only when the purpose of

the analysis is defined is it possible to select the appropriate ratios and items for analysis.

The results of the analysis are then compared and evaluated in a trend analysis.

Finally the decisions require a prediction based on the ratio and trend analysis.

7.3 ANALYSING PROFITABILITY

The use of the profitability ratios and then a trend analysis over a number of accounting periods

or years are useful when analysing profitability. Profitability is an indicator of the viability of the

business or its ability to sustain itself into the future.

We will use information from the following balance sheet and income statement summaries to

work through some examples. We will refer to this set of information as Document Set 1.

• What is the purpose of the analysis?• What are the appropriate tools to use?

SELECT

• With other companies• With previous years• With the industry• With budgets• With ideal targets

COMPARE

• Is it good or bad?• Was the result expected?• If bad, why?• If good, can it be maintained?• Who/what is responsible?

EVALUATE

• What is likely to happen if no action is taken?

• What improvements can be made?

PREDICT


ABC Company is a retail company with its main business being the purchase of CD’s from

manufacturers, which are then sold in bulk to retail outlets and music shops. The figures provided

below are not set out in accordance with GAAP, but rather as a financial analyst would prepare

them in a spreadsheet format.

ABC Company LTD

Balance Sheet information at 30 June

2006 2007 2008 2009

R R R R

EQUITY AND LIABILITIES

Shareholders’ equity 45 745 44 651 49 225 59 218

Non-current loan 6 719 11 187 14 314 21 670

Current liabilities 7 228 8 436 13 217 18 453

Creditors 4 246 4 827 8 986 12 810

Other 2 982 3 609 4 231 5 643

59 692 64 274 76 756 99 341

ASSETS

Fixed assets

Tangible assets 29 444 32 499 43 908 64 047

Investments 12 032 11 881 8 102 5 608

Current assets 18 216 19 894 24 746 29 686

Inventory 3 807 12 041 15 074 17 224

Debtors 8 183 5 614 8 939 11 406

Cash resources 6 226 2 266 733 1 056

Total assets 59 692 64 274 76 756 99 341

ABC Company LTD

Income Statement for the Year Ended information at 30 June

2006 2007 2008 2009

R R R R

Sales (gross revenue) 128 415 141 481 195 016 275 855

Cost of goods sold 106 634 125 605 162 383 230 822

Gross margin 21 781 15 876 32 633 45 033

Revenue from investments 2 982 2 376 827 897

24 763 18 252 33 460 45 930

Expenses 12 302 13 934 16 939 18 375

Operating expenses 4 026 4 320 4 520 5 026

Selling expenses 2 364 3 142 3 862 4 216

Depreciation 5 912 6 472 8 557 9 133

Net operating profit 12 461 4 318 16 521 27 555

Interest 816 1 454 2 290 3 900

Net profit before tax 11 645 2 864 14 231 23 655

Taxation 4 658 958 6 057 9 462

Net profit attributable to ordinary shareholders 6 987 1 906 8 174 14 193

Dividends 3 600 3 000 3 600 4 200

Net profit for year 3 387 (1 094) 4 574 9 993

Accumulated profit at beginning of year 12 358 15 745 14 651 19 255

Accumulated profit at end of the year 15 745 14 651 19 225 29 218


Additional information from financial statement notes:

All sales and purchases are on credit.

Information for the previous accounting year: Sales R119 122.

Note: The 2009 figures from Document Set 1 are used to illustrate calculation of all the ratios

which follow in the rest of the learner guide.

7.3.1 Applying Ratios to measure Profitability

We have selected five primary aspects of profitability which are commonly identified in various

industries.

The ratios attempt to reflect the profit per rand of sales or the profit per rand of capital invested,

such as:

Gross margin.

Net margin.

Return on assets before interest and tax.

Return on capital employed.

Return on equity.

Gross margin percentage

(GM)

Gross margin = gross margin X 100

Sales

= 45 033 X 100

275 855

= 16,3%

This ratio indicates the percentages by which the total selling price is greater than the cost prices.

A gross margin percentage of 16,3% indicates that for every R1 of sales, 16,3 cents was

gross profit. The remaining 83,7 cents in each rand is the cost price of the goods.

The trend for ABC Company shows:

Gross margin 2006

17,0

2007

11,2

2008

16,7

2009

16,3

When comparing this with previous years, the ratio has dropped from 17,0% in 2006 to the

current 16,3%. It is apparent that ABC Company had pressure on its gross margin in 2007, as

gross margin fell to 11,2 %. This could have been from two sources:

Pressure on selling prices as a result of competition in the industry.

Upward pressure on costs as a result of inflation or other cost factors.


It is important to note that the rand amount of gross margin has more than doubled over

the period as a result of the growth of sales.

Net margin (NM) Net margin

= Net profit to ordinary shareholders X 100

Sales

= 14 193 X 100

275 855

= 5,2%

This ratio indicates the percentages by which the total selling price eventually becomes net profit.

The net margin percentage of 5,2% indicates that for every R1 of goods sold, 5,2 cents

eventually becomes profit attributable to the ordinary shareholders.

If turnover increases, then each time R1 is received, 5,2 cents will accrue to ordinary

shareholders as net profit.

The faster the turnover, the greater will be the accumulation of 5,2 cents and the larger

the ultimate net profit.


Net margin 2006

5,4

2007

1,3

2008

4,2

2009

5,2

The net margin has followed similar trend to that of the gross margin, with the percentage

achieved in 2009 being the high point.

It would seem that following the slump in 2007, ABC Company has recovered well and it is likely

that the net margin will increase in 2010.

Return on assets before

interest and tax (ROABIT)

ROABIT = Net operating profit X 100

Total assets

= 27 555 X 100

99 341

= 27,7%

ROABIT ratio indicates how well total assets have been used in earning profit, before any parties

are rewarded by distribution of the profit, including the South African Revenue Service (SARS) in

the form of tax ad the providers of debt capital by way of interest.

Every rand invested in total assets earned 27,7 cents


ROABIT 2006

20,9%

2007

6,7%

2008

21,5%

2009

27,7%


The ROABIT has had a drastic drop in 2007 and 2009 is the best achievement in the four-year

period.

Return on capital

employed (ROCE)

ROCE = Net operating profit X 100

Shareholders’ equity + long-term loans

= 27 555 X 100

59 218 + 21 670

= 27 555 X 100

80 888

= 34,1%

Return on capital employed has been calculated using only long-term capital and attempting to

measure the net profit before tax and before the providers of long-term capital have been

rewarded, by using the profit before interest has been deducted.

A return of 34,1% indicates that for every R1 of total long-term capital employed, 34,1

cents has been earned before tax.

This means that 34,1 cents in every R1 is available to pay interest, tax and shareholders.


ROCE 2006

23,8%

2007

7,7%

2008

26,0%

2009

34,1%

Apart from 2007, the organisation was quite profitable.

Return on equity (ROE) ROE = Net profit to ordinary shareholders X 100

Shareholders’ Equity

= 14 193 X 100

59 218

= 24,0%

The return on equity is the residual net profit which is available to ordinary shareholders. When

net profit is divided by the shareholders’ equity, the result is the return on shareholders’ funds.

While not arithmetically sound, the net profit for the year attributable to ordinary shareholders is

customarily divided by the shareholders’ equity at the end of the year.


ROE 2006

15,3%

2007

4,3%

2008

16,6%

2009

24,0%

A return of 24% is likely to be considered as more than satisfactory by the shareholders.


Note: It can be seen from the figures that interest expense of R3 900 when compared with long-

term loans of R21 670 indicates an average interest rate of 18% for the year.

As interest is a tax deductible expense, the effective cost to the company is less than 18%,

because the interest expense made the amount on which company tax is calculated, smaller.

The company thus pays less tax than it would have paid had there been no interest. The interest

expense has shielded the company from the 30% tax it otherwise would have had to pay, had it

not borrowed funds and thus been unable to deduct the interest from its taxable income.

7.3.2 Analysing Efficiency of Utilising Resources and Capital

The use of efficiency ratios and then doing a trend analysis over a number of accounting periods

or years are useful when analysing the efficient use of resources and capital. We have selected

five ratios to assess the efficiency of the company in managing its fixed and current assets.

Assets are compared to turnover to see how the relative use of assets over the period has

performed in generating sales rands. The three most important working capital items are also

tested to determine whether they have been efficiently used.

The five ratios which we will be calculating are:

1. Fixed assets turnover.

2. Total asset turnover.

3. Days’ inventory.

4. Debtors collection period.

5. Creditors settlement period.

Fixed assets turnover

(sales or gross revenue)

Fixed assets turnover = sales

fixed assets

= turnover

fixed assets

= 275 855

64 046

= 4,31 times

The fixed assets turnover measures the extent to which fixed assets have been efficient in

generating sales.

It indicates that for every R1 invested in fixed assets, R4,31 was generated in sales during

2009.


Fixed assets

turnover

2006

4,36

2007

4,36

2008

4,44

2009

4,31


The trend over the four-year period has been consistent and this is a good indicator of stability

in non-current tangible asset management.

Total assets turnover

Total assets turnover = sales

total assets

= turnover

total assets

= 275 855

99 341

= 2,78 times

This ratio is similar to the fixed assets turnover and measures the extent to which total assets

have generated sales.


Total assets

turnover

2006

2,15

2007

2,20

2008

2,54

2009

2,78

The trend has been more positive than that of the fixed asset turnover ratio and the expectation

is that it will continue to increase, indicating improvement in the management of current assets

relative to the revenue from sales.

Days’ inventory

Days’ inventory = inventory X 365 days

Cost of sales

= 17 224 X 365 days

230 822

= 27,24 days

Days’ inventory ratio measures the quantity of inventory on hand in relation to the quantity

purchased each day.


Days’ inventory 2006

13,03

2007

34,91

2008

33,88

2009

27,24

The number of days’ inventory has shown considerable fluctuation over the four-year period.

The major difference between 2006 and 2007 may have arisen as a result of a change in

policy to keep more inventory on hand, or may have resulted from the decline in trading

activity in 2007 which is evident in all the ratios for that year.


It appears that inventory is beginning to move more quickly and the improvement to 27,24

days in 2009 may signal an attempt to return to the efficiency which was achieved in 2006.

Inventory is clearly the most significant current asset. Changes in this ratio have an impact

on the current ratio as can be from the trends in these two ratios over the last three years.

Debtors’ collection period

Average collection period = debtors X 365 days

credit sales

= 11 406 X 365 days

275 855

= 15,09 days

The debtors’ collection period shows how long debtors take to pay their accounts, by measuring

the number of days from the date of sale to the payment date.

The debtors’ collection period assumes that all sales are on credit. While this may not

always be the case, the comparisons do provide useful information.


Debtors collection

period

2006

23,26

2007

14,48

2008

16,73

2009

15,09

This period has fluctuated from a short collection period of 14,48 days in 2007 to a high of 23,26

days in 2006.

This current year’s figure of 15 days seems to be within the range maintained apart from

the unfortunate lapse in 2006.

Creditors’ settlement

period

Creditors settlement period = creditors X 365 days

credit purchases

To calculate the time taken to settle debts with creditors, the credit purchases for the year must

be known. As the opening and closing inventory as well as the cost of sales for each year are

known, it is possible to calculate credit purchases, assuming that all purchases take place on

credit:

Credit purchases for the year = cost of sales + closing inventory – opening inventory

= 230 822 + 17 224 – 15 074

= R232 972

Creditors settlement

period

Creditors settlement period = creditors X 365 days

credit purchases

= 12 810 X 365 days

232 972

= 20,07 days


The creditors’ settlement period measures how long it takes the company to pay its creditors. It

is determined in the same way as the debtors’ collection period, except that creditors and cost of

sales are substituted for debtors and sales respectively.


Creditors

settlement period

2006

14,50

2007

13,17

2008

19,82

2009

20,07

Creditors are settled promptly although it is apparent that in the last two years, ABC Company

has adopted a policy of keeping the creditors waiting marginally longer.

This may be a symptom of its liquidity problems and scrutiny of the balance sheet indicates

that very low bank and cash resources are currently on hand.

Note that sound management of working capital would try to ensure that the debtors’

collection period is shorter than the creditors’ payment period, an objective which has only

been achieved in recent years.

7.3.3 Making Recommendations after an Analysis

Once the ratio and trend analysis has been done, the analyst is in a position to make certain

recommendations based on the outcome of the analysis. The components of the calculations are

used to create a better outcome of future analysis and to make the required recommendations.

7.3.4 Identifying Opportunities for Growth

Once the ratio and trend analysis has been done, the analyst is in a position to identify where the

organisation can change tactics and do things differently in order to create a better outcome of

the ratio analysis.

7.3.5 Viability

The concept of the going concern is an important accounting concept.

Financial Statements are usually prepared with the assumption that the enterprise is a going

concern, without evidence to the contrary. This assumption implies that the business will continue

its operations for the foreseeable future. Financial viability implies that:

The company will continue its operations in the foreseeable future.

The enterprise is sufficiently profitable (or will be in the future) to continue its operations.

There is inherent worth in continuing operations.

This is related to the concept of ongoing profits. It is important to note that sometimes companies

do not make a profit every year – especially in the first few years of operations. A businessperson

would examine financial statements for their financial viability and also take a view on the inherent

worth of the company.


An analysis of profitability alone is not sufficient to determine the viability of an organisation. The

capability of the organisation to pay its way in the future is important. The capacity of an

organisation to pay its way depends on its level of liquidity.

7.3.6 Evaluating Financial Viability

In order to evaluate the financial viability of an organisation, a combination of the following

information is required:

Financial performance - a measure of the difference (i.e. profit/loss, surplus/deficit)

between revenue and expenses that arises from operations for a period of time.

Financial position – the “position” at a point in time assessed in terms of assets, liabilities

and public equity.

Cash flow – the sources and uses of cash relating to operations, investing in assets and

financing the organisation for a period of time.

7.3.7 Using Liquidity Ratios to Analyse the Organisation’s Viability

These ratios help to determine whether the company will be able to meet its financial obligations

in the short term. It is a measure of liquidity reflected by the working capital, which is the difference

between current assets and current liabilities. Two ratios have been selected, both of which are

frequently used by management:

Current ratio

Acid test ratio

Current Ratio

Current Ratio = current assets

current liabilities

= 29 686

18 453

= 1,61 expressed as 1,61:1

The current ratio is the most commonly used measure of short-term creditors covered by assets

that are expected to be converted to cash in a period roughly corresponding to the maturity of the

claims.


Current Ratio 2006

2,52:1

2007

2,35:1

2008

1,87:1

2009

1,61:1

The current ratio has shown a consistent decline over the four-year period, from a high of 2,52 in

2006 to a low of 1,61 in 2009.


From a scrutiny of the balance sheet it is apparent that the current liabilities have

increased relatively more than the current assets over the four-year period. This may be

a cause for concern and ABC Company would be well advised to ensure that is has

adequate cash resources on hand in order to meet its short-term commitments.

Acid Test Ratio

(Quick Ratio)

Acid Test Ratio = current assets - inventory

current liabilities

= (29 686 – 17 224)

18 453

= 0,68 expressed as 0,68:1

The Acid Test Ratio measures the organisation’s ability to pay off short-term obligations without

relying on the sale of inventories (typically the least liquid of an organisation’s current assets).

This ratio is the real test of liquidity as it removes inventory, which is not easily converted

into cash, from the calculation of current assets.

To interpret this ratio it may be said that the company has 68 cents in cash and near cash

to meet every R1 which will require repayment in the short term.


Acid Test Ratio 2006

1,99:1

2007

0,93:1

2008

0,73:1

2009

0,68:1

The acid test ratio has also declined dramatically over the last four years from a high of 2,19 to

its current low level of 0,68.

Unless convinced that liquidity will not be a problem, it would be well advised to take the

necessary steps to redress the trend away from liquidity.

7.3.8 Using Leverage Ratios to Analyse the Organisation’s Viability

The leverage ratios examine the financing structure of the organisation. They focus on the

combination of owner’s equity and the outside financing (long and short term) used by the

company. Three ratios have been selected or this purpose:

Debt ratio.

Debt to equity ratio.

Interest cover.

Debt ratio

(Total Debt to Total Assets)

Debt Ratio = total debt X 100

total assets

= 21 670 + 18 453 X 100

99 341

= 40,4%


The debt ratio has been defined as total debt compared to tatal assets. The total debt includes

long-term loans and current liabilities.

The ratio of 40,4% indicates that for every R1 used to purchase total assets, 40,4 cents of the

financing was provided by parties other than the ordinary shareholders.


Debt Ratio 2006

23,4%

2007

31,5%

2008

35,8%

2009

40,4%

It is apparent that over the four-year period ABC Company has moved towards a policy of using

more debt to finance its assets.

Debt to equity ratio

Debt to equity = long-term loans X 100

Shareholders’ equity

= 21 670 X 100

59 218

= 36,6%

The debt to equity ratio concentrates only on long-term debt, i.e. debt that requires a reward in

the form of interest.

The comparison is between long-term loans and shareholders’ equity. The ratio may be

interpreted to mean that for every R1 of capital provided by ordinary shareholder, 36,6 cents was

raised through long-term loans.


Debt to equity 2006

14,7%

2007

26,5%

2008

29,1%

2009

36,6%

The debt to equity ratio has been a little erratic over the four years, but a definite trend to

increasing this ratio is apparent, with the highest percentage of debt to equity over the four years

in 2007.

Interest cover

(Times Interest Earned)

Interest cover

= Net operating profit before interest and tax X 100

Interest

= 27 555 X 100

3 900

= 7,07 times


The interest cover / times interest earned ratio shows the number of times which the net profit is

able to cover the interest which is due. It is calculated before tax and interest in order to reflect

the position most accurately.


Interest cover 2006

15,27

2007

2,97

2008

7,21

2009

7,07

In the difficult year of 2007, ABC Company’s creditors were most at risk of not receiving their

interest as net profit achieved less than three times the required interest expense. Had it not

been for investment income, the profit would only just have covered the interest commitment.

7.3.9 Formulas used to calculate ratios

Ratio analysis is not governed by GAAP or minimum disclosure requirements as in the case of

audited financial statements. It is not an exact science either; therefore the scope to create useful

ratios is unlimited and never-ending.

The ones we focus on are highly applicable to credit risk assessment and very suitable from a

banker’s point of view.

Ratio Formula Meaning and interpretation

EQUIDITY

RATIOS

Current ratio

Current assets

Current liabilities

*This ratio can also be

expressed as a %

This ratio indicates the ability of the business to

meet its short-term commitments. The quality of

the current assets must first be investigated

before conclusions can be reached.

Quick ratio

(acid test)

Current assets – inventory

Current liabilities

*This ratio can also be

expressed as a %

This ratio indicates the degree to which the

business depends on selling inventory to meet its

short-term commitments. Old and obsolete

inventory is worthless and cannot be converted to

cash.

Accounts

receivable

Collection period

Debtors x 365/1

Turnover*

*Credit sales should be

used if available.

This ratio indicates how long it takes on average

to collect money from the debtors of the business.

The longer it takes the less active the business is

and it is also costing the business interest if an

overdraft facility is used to finance the debtors'

book. The shorter it takes, the more liquid the

business will be.



Creditors

Payment period

Creditors x 365/1

Purchases

This ratio indicates how long it takes the business

on average to pay its creditors. The longer the

period, the better the chances are that the

business can lose discounts, but on the other

hand it implies that cash is available within the

business for a longer period and this could save

interest if an overdraft facility is used.

Inventory

Turnover

Closing inventory x 365/1

Turnover*

*Cost of sales should be

used if available.

This ratio indicates how long it takes to sell

inventory, or alternatively for what period the

business carries its inventory on the shelves.

The longer it takes to sell the inventory, the longer

cash will be tied up in this asset and it can have

a serious impact on the liquidity of the business.

Money tied up in inventory can cost a business

interest and the cost of physically storing the

goods. There is also the risk of becoming

technologically outdated and losing its value. If

we cannot obtain closing inventory or credit

sales, use inventory and revenue instead – it still

shows a trend.

PROFITABILITY

RATIOS

Gross profit

margin

Gross profit x 100/1

Revenue (sales)

This ratio indicates what percentage of

revenue/sales is left after the cost of sales has

been deducted.

Due to minimum disclosure requirements it is not

always possible to calculate this ratio.

Net profit margin Profit before tax* x 100/1

Revenue (sales)

*Can also use profit after

tax.

This ratio indicates what percentage of income

remains after all costs have been deducted.

The choice of before or after tax in the formula is

determined by the objectives of the answer

achieved.

Return on assets

(ROA)

Profit after tax + Interest

paid

Average total assets

x 100/1

This ratio indicates how much profit was

generated by using the assets of the business.

The ratio is an indicator of how productively the

assets are being utilised.

Return on capita

employed

(ROCE)

Profit after tax x 100/1

Equity + long-term

liabilities

This ratio indicates how productively the long

term capital (long-term loans and owners’ funds)

was used.

Return on

investment

(ROI)

Profit after tax* x 100/1

Owners’ equity (ordinary

capital & reserves)

*In the case of a company

the dividend for

preference shares must

be deducted.

The return on investment ratio tells the owners

what the returns on their investments in the

business were. In the case of a company,

preference shares are not included in the equity,

only ordinary shares



Earnings per

share (EPS)

Profit after tax –

preference dividend

Number of issued ordinary

shares

This ratio simply states what the amount of

earnings/profits is that belongs to the ordinary

shareholders per share issued.

LEVERAGE/

GEARING

RATIOS

Equity ratio

Ordinary shareholders

funds divided by total

equity + long-term

liabilities x 100/1

*Total owners’ funds in the

case of non-company

business. (These refer to

capital & reserves.)

This ratio expresses the percentage of long-term

capital in the business that was supplied by the

owners. In the case of a company, it is preferable

to work with ordinary shares only because

preference shares are often redeemable and

seen as “debt”.

Debt ratio Total debt x 100/1

Total assets

This ratio expresses the percentage of debt in the

business against total assets.

Debt/equity

Ratio

Long-term Debt

Ordinary shareholders

Equity (ordinary capital &

reserves)

This ratio is a simple expression of how much

long term debt there is in the business for every

R1-00 of owners’ funds.

Times interest

covered

Earnings before interest

and tax divided by (EBIT)

(profit from operations)

Interest Paid

This ratio measures to what extent the business

can meet its interest commitments from profits

earned during the same period.

This is an important ratio for bankers because if

the business cannot service the interest and debt

owed to the bank, it can lead to losses for the

bank. The higher the debt ratio of a business, the

more interest will normally have to be paid, which

can have a negative impact on this ratio.

ACTIVITY

RATIOS

(FOR

EFFICIENCY)

Total asset

turnover

Revenue divided by Total

assets

This ratio indicates the efficiency with which the

business uses all its assets to generate

sales/revenue. If this figure becomes too high on

the other hand, it could indicate that the business

is chasing too high a turnover for the assets

available – it is in fact overtrading.

Fixed assets

turnover

Revenue divided byTotal

fixed assets

Same as above, only here the focus is on the

efficient use of fixed assets.

MARKET

VALUE

RATIOS

(INVESTORS

RATIOS)

Dividend yield

ratio

Dividends per share x

Market price per share

This ratio indicates the return that investors are

receiving on their investments. The return is

normally low, but many investors are really

interested in capita growth by way of increased

share prices. The higher the dividend yield, the

higher the share price will be.

Earnings yield

ratio

Earning per share x 100/1

Divided by Market value

per share

This ratio is sometimes regarded as the investors’

capitalisation rule. The lower the earnings yield,

the higher the quality of the share as perceived

by investors.



Dividend pay-out

ratio

Dividend on ordinary

shares divided by Net

profit after tax –

preference dividend

This ratio is calculated to determine how much of

the earnings that belong to owners are in fact paid

out in the form of dividends.

Price/Earnings

ratio

(P/E ratio)

Market price per share

divided by Earnings per

share

This ratio is used to calculate whether a premium

can be paid, or discount obtained, on a share.

Regular calculations of break-even ratio comparisons over 4 – 5 year period

working capital by month

Measure results against industry

Acknowledgements:

Adapted with kind permission of Zelda Rose, author of Strategic Leadership Development, published by

Pearson Education SA Pty Ltd, Maskew Miller Longman, 2007

HOW TO WRITE A 1-PAGE BUSINESS PLAN 64

8. 3HOW TO WRITE A 1-PAGE BUSINESS PLAN

How to Write a One-Page Business Plan

When starting a new business, everyone always talks about a business plan and the importance

of having one, and they would be right – it is essential for every entrepreneur or business owner

– it is the roadmap for your business and a necessary task to complete. However, most new

businesses put off writing their business plan as it seems like such a daunting task – anyway,

there are always a million other things to keep you busy!

The good news is, it doesn’t have to be that difficult – a business plan can be as simple as a one-

page document. Let’s be honest, in a time of information overload, the shorter the better – a one

page plan will allow you to get the idea of your business across quickly and succinctly. It’s actually

a very good exercise to trim down your business plan to the absolute minimum—it forces you to

trim needless words and communicate your business idea clearly, with minimal clutter. It’s about

creating a document that can cover all your needs at the beginning and get you organised enough

to get started – the more in-depth critical thinking will come later…

8.1 THE KEY ELEMENTS THAT NEED TO BE CONTAINED IN ANY GOOD BUSINESS PLAN

WOULD BE THE FOLLOWING:

1. The Customer Problem

2. Your Solution

3. Business Model (how you make money)

4. Target Market (who is your customer and how many of them are there)

5. Competitive Advantage

6. Management Team

7. Financial Summary

8. Funding Required

3 Quickbooks – 11 July 2014 - Blog

HOW TO WRITE A 1-PAGE BUSINESS PLAN 65

The content of your business plan is by far the most important thing. Think carefully about what

you are trying to communicate. Too many companies spend time focusing on presentation and

graphical display of their plans, when what they are saying and how they are saying it is really the

most critical aspect of it all. Presentation is important, but content is king.

8.2 HERE ARE FIVE EASY STEPS TO A ONE-PAGE BUSINESS PLAN:

1. Start with your vision. Begin the plan by thinking of the end. You have to communicate up front

where you want to go with your business to set the tone for your plan. Is the plan to grow this

business to sell? Do you want the business to be a legacy that will last your lifetime? What’s the

big vision for the end goal? It’s important to start with the end in mind. Your vision should

summarise that well.

2. Formalise your mission statement. You know what your vision is, now you need to describe what

you’re going to do to accomplish that vision in a brief, accessible way. This will be the daily

reminder of why you’re doing what you’re doing every day.

3. List your objectives. Think of your objectives as the bullet points of deliverables you plan to

achieve. For example, “dominate at least 15 percent of the market of my niche by 2016,” or HR

objectives such as “hire one full-time sales person by year’s end.” These should be the big goals

you want to achieve with a timeframe attached to them.

4. Form your strategies. Your strategies describe how you plan to achieve your objectives. What’s

the marketing plan? Sales strategy? Will you devote your time to research and development?

What are the overarching strategies you will follow to achieve your objectives?

5. Create an action plan. You have the objective, you’ve decided on a strategy, now what actionable

steps will you take to make sure your business maintains the momentum to achieve your

objectives and reach your goal? These should be short-term actions and daily tasks — things that

you can start doing now to work toward the big picture.

Tackling a business plan can be challenging, but it doesn’t have to be overly complicated. Simplify

the process by following these five easy steps to a one-page business plan, then work in the 8

key elements that need to be included within their relevant headings and you will be well on your

way.

Consider what you would want to hear as a potential investor

What differentiates you from your competitors

Do you still dream?

TENDERS 66

9. TENDERS

“Tendering” is the term used when a business offers products or services to organisations that are required by law to call for public responses to meet their organisational requirements.

Origin of the term – Dictionaries explain the etymology as coming from Old French “tendre”,

which means “to offer”

Definition of tendering:

“Tendering” is the acquisition of goods and/or services at the best possible total cost of

ownership, in the right quantity and quality, at the right time, in the right place and from the right

source for the direct benefit or use of corporations, or individuals, generally via a contract. Simple

procurement may involve nothing more than repeat purchasing. Complex procurement could

involve finding long term partners – or even 'co-destiny' suppliers that might fundamentally commit

one organisation to another.

The origin of the tender process lies in the legislation that prescribes those organisations that are

required to request tenders. Knowing who is required to request tenders will enable you to look

for tenders in the right place.

According to legislation contained in the Preferential Procurement Regulations, 2001, an organ

of state is required to request tenders before procuring products or services.

In the regulations “Tender” – means a written offer or tender in a prescribed or stipulated form in

response to an invitation by an organ of state for the provision of services or goods.

An organ of state is defined as follows in the Preferential Procurement Policy Framework Act,

2000:

A national or provincial department as defined in the Public Finance Management Act,

1999 (Act No. 1 of 1999)

A municipality as contemplated in the Constitution.

A constitutional institution defined in the Public Finance Management Act, 1999 (Act No.

1 of 1999)

Parliament.

Provincial legislature.

Any other institution or category of institutions included in the definition of “organ of state”

in section 239 of the Constitution and recognised by the Minister by notice in the

Government Gazette as an institution or category of institutions to which this Act applies.

TENDERS 67

The two major role-players in the above definition are:

1. The tenderer

This refers to the company (business) offering products or services in response to a call made by

an organisation which is required to call for the tender.

2. The requester

The organisation calling for a tender or tenders to be submitted is referred to as the requester.

However, there are other less obvious role players with their own specific needs and requirements

as well; namely:

External customers.

Employees.

Shareholders.

Society.

The following diagram illustrates their needs:

Figure 12 - Tender Requester Needs

9.1 WINNING TENDERS

Getting the process right not only saves time and effort but has the potential to set up lucrative

income streams. Many suppliers or potential tenderers greet the arrival of an invitation to tender

with feelings close to panic. The best antidote is to prepare your tender methodically.

The prime function of a tender can be seen from the standpoint of the contractor as winning

business through a competitive response to the client’s requirements. It is important to review

your tender from the client’s perspective.

TENDERS 68

The client sets up the competition and judges the strengths of each competitor. A tender that

shares identity and understanding of the client is more likely to succeed.

The tender has to prove to the client that the company tendering took the client’s requirements,

interpreted them accurately, and developed the tender specifically for the opportunity with care in

preparation. Patching tenders together with copy and paste commands can be dangerous.

Overselling or inflating the tender with unrealizable promises will catch up with you!

The client will consider the following questions when inviting tenderers to tender:

1. Value for money – our existing suppliers or new ones?

2. Will a change of contractors bring practical benefits in terms of service quality and

deliverables?

3. Will we enjoy a more constructive working relationship with new contractors?

Your most valuable weapon and your strongest marketing tool is your performance record on

current and past contracts for the client and others. Your track record is imperative. Include up

to date testimonials from your current clients when tendering for a new client. Your tender

document has to prove that you are the front-runner in terms of dependability of your contract

management and technical expertise. There is a consensus among evaluators that the tenders

most likely to win are those prepared concise, with substance and according to the brief and

request.

If you have built a good relationship with your existing clients, delivered on brief, on budget and

on time every time, earned their trust, you should get an early lead into opportunities while they

are in the process of being defined. You may even be afforded the opportunity to assist them

develop their ideas about the work and to the shape the tender specification. This could be

regarded as an investment in your customer relationship.

Guidelines to set you on course:

1. Focus on the client’s needs;

2. Match the tender to the opportunity;

3. Be honest and realistic about what you can achieve;

4. Performance is the essential credential;

5. Readability and appearance will make a difference;

6. Be in control and stay calm.

Acquiring goods/services through the tender process:

Promotes private sector accountability / buy in

Ensures fairness, transparency and equity in the supply of goods or services

Promotes the use of HDI’s in the Public Sector

Discourages the use of non-competitive suppliers

TENDERS 69

Obtains a view of potential alternative solutions

Promotes competition, in order to get the best price / solution

9.2 CATEGORIES OF TENDERS

Business activities can be divided into two broad categories namely products/goods and

services. Some activities are more product (production) orientated and others are more service

(consultation, advice etc.) orientated.

It is important to distinguish whether a company’s business activity is service orientated or

production orientated. When looking at tender requests one also needs to understand if the type

of product called for is service or product related; for example, engineering and construction

usually need a combination of goods and services, including building and engineering

infrastructure, arranged for the development and provision of an asset or refurbishment of an

existing asset.

It is important to understand that even if you are a small business and can only supply your service

or goods on a small scale there are opportunities for you to tender to various companies and

administrations.

Tenders are requested by National government departments, Provincial government

departments, the roughly 450 municipalities, as well as big companies in the private sector. This

is a lucrative form of gaining business but you have to:

Get to know and understand the company or administration you want to tender for.

For instance, what does your local municipality normally put out to tender and how often?\

Get to know the people who do the buying or procurement. If you can, seek an

interview with the buyer to find out what he/she needs and whether you can offer it.

Remember that you can also get potential business by quoting if the amount is below a

certain threshold.

In order to tender, you usually have to fill in a tender document. This document

contains the terms and conditions of the tender. If you build good relationships the buyer

or procurer may also be willing to give advice on how to fill in the tender document. If

necessary you can even ask a lawyer to help you understand it. It is important to note that

tender requests have closing dates and you can either miss the deadline or there may be

penalties for late delivery.

In order to ensure that your company can be contacted or approached for quotations you must

apply to be listed on the database of approved suppliers for those organisations that you wish to

target for business.

Each individual organ of state will have its own database maintained by its procurement

department. These departments can be contacted directly for more details.

The first or primary step is the “three quotation method” where at least three companies are invited

to submit written quotations and one of the quotations is accepted, based mainly on price.

TENDERS 70

This method can however only be used for purchases below a particular threshold.

Purchases above the threshold need to be obtained through the tender process.

The amount in question is stipulated within an organisation’s individual procurement policy. This

in turn has to comply with preferential procurement legislation.

9.3 STANDARD CONDITIONS OF TENDER

The following is a summary of the standard conditions of any tender, which will be discussed in

more detail as we go along:

1. General

Actions.

Interpretation.

Communication.

The Company’s rights to accept or reject any tender.

2. Tenderer’s Obligations

Eligibility.

Cost of tendering.

Check documents.

Confidentiality and copyright documents.

Standardised specifications and other publications.

Acknowledge receipt.

Site visit and/or clarification meeting.

Seek clarification.

Insurance.

Pricing the tender.

Alterations to documents.

Alternative tenders.

Submitting a tender.

Closing time.

Tender validity.

Clarification of tender after submission.

Submit bonds, policies etc.

Fulfil BBBEE requirements.

3. The Company’s Undertaking

Respond to clarification.

Issue addenda.

TENDERS 71

Return late tenders.

Tender opening.

Two-envelope system.

Non-disclosure.

Grounds for rejection.

Disqualification.

Test for responsiveness.

Non-responsive tenders.

Arithmetical errors.

Evaluating the tender.

Clarification of a tender.

Acceptance of tender.

Notice to unsuccessful tenderers.

Prepare contract documents.

Issue final contract.

Sign form of agreement.

Complete adjudicator’s contract.

Provide copies of the contract.

9.4 PROBLEMS WITH TENDERING

Unfortunately, in spite of the aim to be totally transparent, many tenderers or potential tenderers

still report the following problems with the tendering process:

Little or poor interaction between procurement units and prospective tenderers.

Perceived lack of transparency in award process.

Tender information does not reach emerging businesses.

Language, jargon, legalese, technical language. Also, often poorly written and difficult to

understand.

Various public sector procurement units use different tender documentation.

9.5 TENDER PROCESS

The organisation (requester) who is requesting a tender usually goes through a process of

preparing a tender request to obtain the service or product they require.

The next phase is the notification/ publishing the availability of a tender. This phase entails

the publication of a notice declaring the availability of tender documentation. Instructions on how

to gain access to the tender document(s) are described in the tender notice. In this way, the

organisation is able to keep track of the companies requesting the document, the number of

documents released and thus the number of expected responses.

TENDERS 72

Once the prospective tenderer has noted the availability of a tender and having obtained the

tender document the next phase is to prepare and submit a response which is the actual

tender.

An adjudication panel is usually set up to evaluate the responses received and to allocate points

against listed criteria.

A supplier is selected based on the results of the adjudication. It may happen that more than

one potential supplier is identified, in which case a short list is compiled from which a supplier is

chosen.

The engagement of the approved supplier usually requires a contract stipulating the obligations

of both parties. At this point the tenderer becomes the contractor.

9.6 PROCUREMENT PROCESS

9.7 WHERE TO FIND TENDER OPPORTUNITIES

Remember that a distinction is made between a tender request notice and tender documentation.

The tender notice is only the first source of information encountered in the tendering process.

Tender request notices are usually found in one of three places:

Newspapers.

Tender notice boards.

The Internet

Social Media

Requirement Cycle:

Make or Buy?

- Development of Specifications & Requirements.

- Business Needs Analysis.

- Functional Specification.

- Technical Specification.

Requisition Cycle:

Issue of Tenders.

Tender Evaluations.

Due Diligence.

Bargaining Cycle

Negotiation.

Award Cycle

Contracts drawn up.

Contractual Cycle

Quality Assurance.

Change Control.

TENDERS 73

Newspapers are a good place to start when looking for tender notices. Most newspapers have

entire sections for tender notices.

Tender notice boards are required on the premises of all organs of State. These are usually

situated in their head-office foyer. Notice Boards must be accessible to the public during business

hours. A disadvantage is that notices are posted to be read only, without the provision of printed

material that can be taken away. You will need to make your own notes.

As in the case of most published information, the Internet is also a place where tender information

can be found. There are numerous Websites carrying updated tender information. Note that many

of these require a subscription:

– www.info.gov.za/documents/tenders/index.htm

– www.dailytenders.co.za

– www.joburg.org.za

– www.tendersonline.co.za

– Parastatal websites

9.8 THE BRIEFING SESSION

Many organisations require potential tenderers to attend a compulsory briefing session, during

which the following usually happens:

In many instances, a non-refundable payment is made for the tender document.

An attendance register with tenderers’ contact details is completed.

Explanation of structures, technical specifications, relevant policies and tender specifics.

It is important to ensure that persons already involved with tenders in your organisation are sent

to these briefing sessions. Valuable information and specific requirements are shared at briefing

sessions. Take note of who are present at the session. Don’t forget your pen and notepad to

record the discussion, requirements and answers to questions raised by your competitors.

Thereafter all questions (telephonic or e-mail) are supplied to ALL attendees together with

relevant answers.

9.9 EVALUATING WHETHER TO TENDER OR NOT

Before making a final decision to spend time, money and resources on a tender there are some

serious practical considerations. You must decide whether you can tender or why you cannot

tender. This decision must be made after careful consideration because either way you can lose

a lot of money. Not to tender when you could have gained the business, or to tender and not

being able to deliver can result in serious damage to your reputation and your finances.

The latter is true because once you have been awarded a tender you enter into a legal contract

with the awarding body and this usually includes performance standards.

http://www.info.gov.za/documents/tenders/index.htm

http://www.dailytenders.co.za/

http://www.joburg.org.za/

http://www.tendersonline.co.za/

TENDERS 74

The following simple questions will point you in the right direction:

Do you have the capital or will you be able to access the capital to invest in raw materials

and equipment you may need?

Can you deliver by the due date?

Can you achieve the quality standards required?

Do you have the employees or will you be able to appoint additional competent staff once

the tender has been awarded?

If the contract duration is long, have you taken into consideration any changes in raw

material prices that may affect your profit margins?

Having carefully studied a tender notice and assembled as much information as possible from the

notice alone, it is time to decide whether to request further information. Answers to the following

pertinent questions will assist you in deciding whether to proceed and obtain the tender

documentation or not:

Can we do this?

Can we do this with help?

Are we likely to decide not to respond once more information is forthcoming from the

documentation?

How much money will be spent?

In most circumstances finding out more is the only way to make an informed decision. Finding out

more, means that the decision has not yet been made because you need more information. The

tender documentation will be obtained (this decision is made easier if the tender documentation

is free). You may still decide not to pursue the business and will suffer the loss of any expense

between now and the time of that decision. Doing nothing is always an option in any decision-

making process. What matters however is the amount of energy spent before deciding to do

nothing.

It is clear that the decision to tender must also include an objective evaluation and understanding

of the business activity levels required by a specific tender. Understanding your own business

activity will enable you to determine if you will be able to meet the business activity levels required

by the tender.

Apart from your business activity you also need to evaluate the internal and external factors of

human resources capacity that impact on a specific tender. This sounds complicated but it boils

down to the following:

Are you positioned to deliver the goods with your current personnel?

Will you be able to expand should winning a tender require that you do so?

Will you be able to find the money, space and people to deliver the tender?

TENDERS 75

Expansion includes matters such as the financial resources, working space as well as additional

skilled personnel to deliver what is required.

Remember, failure to deliver what is required at the stated costs and within the time agreed will probably make you liable for penalties in terms of the contract. Thus be sure that you understand what is expected from you. It is important have access to e-mail if you’re serious about doing business in the tender market. This enables you to communicate effectively and to receive documents in electronic format.

9.10 EVALUATING CRITERIA

Cost of solution.

Time of implementation.

Experience.

Quality of solution.

Delivery.

Hints

1. Only tender for work that you are sure you can do.

2. Always provide the information you are asked for. If you cannot do so, check whether your

tender will be accepted before you send it back.

3. Make sure you accurately answer all the questions.

4. Plan your tender around the timetable the buyer gives you to make sure that you can meet

all deadlines.

5. If you are not sure of anything, ask the buyer in good time. Do not miss the given deadline.

6. If your tender is unclear and the buyer asks you to explain something, you must give your

explanation by the original deadline, unless they tell you otherwise.

7. Know about any quality-assurance standards that affect your industry.

8. Ask the buyer about any policies they have on quality assurance when awarding contracts.

9. Always include a plan for skills transfer.

10. Never use words / terms that are out of context of tender, e.g. Mentoring, etc.

11. Writing and language correct and understandable.

12. Explain how your solution will make the client look good.

13. Expand on communication strategy and skills.

14. Make this a team exercise.

15. Emphasise management skills, for example:

– Management of staff

– Project Management (especially in terms of scope changes)

– Performance driven, monitoring and reporting

TENDERS 76

As a guideline, an enterprise that is ready to tender must:

Be a registered business. (a sole trader or partnership must be registered or licensed with

the relevant local authority, must have a bank account and must be registered with the

South African Revenue Services with an up-to-date tax clearance certificate)

Have a good banking record, credit history and relationship with its suppliers and clients.

Be able to deliver - on time, on budget and according to specifications.

Be up to date with its taxes.

Pay its bills on time.

Have the required cash-flow and other resources to complete the contract.

Be able to deliver goods or services of consistent quality.

Have qualified employees.

Already have, or be able to acquire, the right equipment, clothing and accessories to

deliver the services/products tendered for.

Have registered its employees with the Department of Labour (UIF, Skills Development

Levy, Workmen's Compensation etc.)

Joint ventures

When two businesses form a joint venture (a partnership between two businesses, referred to as

a JV) they each contribute to the project and share the profit. In this way two (or more) small

businesses may be able to win a large tender that neither would have been able to take on alone.

Remember that a JV must be in writing as part of a formal agreement and both parties must

present themselves in the documentation.

9.11 EMPOWERMENT CRITERIA

B-BBEE RATING CRITERIA FOR SUPPLIER AND TENDER EVALUATION

Criteria 1 2 3

Black ownership 10% to <20% 20% to 50% >50%

Black management 10% to <20% 20% to 50% >50%

% Black skilled personnel 10% to <20% 20% to 50% >50%

% Procurement from BEE suppliers 5% to 9,9% 10% to 20% >20%

% Black female management 1% to <5% 5% to <10% 10% to 100%

Employment of people with

disability 2% (1 person)

Other Black Empowerment

initiatives Maximum 1

Figure 13 - Empowerment Criteria

TENDERS 77

Tender Scorecard

ELEMENT CODE SERIES REVISED WEIGHTING (2014)

Ownership 100 25 points

Management Control (MC) 200 15 points

Skills Development (SD) 300 20 points

Enterprise and Supplier Development (ESD) 400 40 points

Socio-Economic Development (SED) 500 5 points

TOTAL 105 points

Figure 14 - Tender Scorecard - Updated 2014

Detailed evaluation criteria

Ownership 60% of the business owned by

the historically disadvantaged

30% within 6 months

40% within 12 months


Management

60% of all levels of

management representing

demographics




Affirmative Action Demographic structure

40% at all levels by 2002



Transfer of Skills

All management able to

operate competently at

functional levels

Increase in competency

levels of all employees

Mentorship for 36 months

Leadership transformation

Training schedule

Other BEE initiatives

Decentralisation non-core

BEE suppliers strategy

Community involvement

Employee participation

Creating new business

Supporting Black Business

Related social projects

Shareholding

Productivity Improvement

12 months remain the same

24 months industry related

36 months global standards

Profitability

Cash flow management

Growth

Discipline

48 months “cash flush”

Sales increase > inflation

Cost < inflation

9.12 TENDER PREPARATION AND SUBMISSION

How you represent your business is important in winning a tender and you will have to prove that

your business is capable of meeting the requirements of the tender.

Usually, an invitation to tender is very specific about the practical tasks to be accomplished.

TENDERS 78

Be sure that you understand what is expected and be realistic about your ability to accomplish

those tasks and that you can convince the requestor in this regard. Don’t be afraid to ask

questions that will help you to clarify the exact needs and expectations of the requestor. It is

always better to ask than to assume!

Tender documents must be prepared with great care and precision! Follow the instructions

carefully. Even the smallest error may result in the cancellation of your tender application.

The list of businesses requesting tender documents given above is a sure indication that you have

competition, so be sure to be correct as well as professional in your approach. Your nearest

Tender Advice Centre (TAC) will help you get hold of and complete the tender documents.

Be quite sure that you have enough time to prepare and submit an offer before the due

date.

It is up to you to deliver or post your tender documents to the correct address by the due

date, and indeed at the correct time. If the closing time is 12 noon, your tender will be

disqualified if it is handed in at one minute past 12.

The tender will include all the requirements and specifications for the goods and services

to be supplied. Be quite sure that you will be able to comply.

Include in your tender details all the relevant experience you have in relation to the

proposed contract.

Remember to:

Include your VAT registration number, if you have one.

Guarantee the quality of your products or services. Also provide details of any SABS or

ISO marks or sign of quality assurance that you are entitled to use.

Offer to make refunds if you fail to deliver as agreed.

Declare the percentage or quantity of imported products.

State patents and details of any royalties.

Describe the packaging.

Give the time, place and frequency of delivery.

Provide samples of products or goods if required.

Complete the tender documents in black ink and sign alterations in full.

Standard Documents Required:

Tax clearance certificate.

Company information.

Short company profile.

Business Plan.

Articles of Incorporation and amendments.

TENDERS 79

PAYE and VAT certificates.

Relevant references.

Product / Service information.

Employment equity strategy and policy.

Social responsibility strategy and actions.

Skills matrix and CV’s of key staff.

9.13 TENDER COSTING

Costs are normally requested to either exclude or include VAT in the request for tender

document – be consistent.

Detail costs per module / unit / service.

Ensure all costs are included (correlating to the scope of work) – think entire strategy

through carefully and ensure all costs are considered

What to consider when costing:

Figure 15 – Costing considerations

In order to be competitive, you would normally add a cost plus 7.5% to determine a tender price.

This may vary according the level of expertise and general availability (market) of the service or

goods required.

Preference Certificates:

ST11

Price preference for:

- Local manufacture

- Local design

- SABS standardization

- CSIR

ST11.1

Points awarded for Price (Np):

Project Profit and

Loss Statement

TENDERS 80

- Np = tender adjudication points awarded for price

- Price of the lowest tender on a comparative basis

- In each case the comparative price of the tender

Equity ownership by PDI’s (Nep)

Equity ownership by Women (New)

Total points = Np + Nep + New

9.14 GENERAL CONDITIONS AND PROCEDURES:

Late tenders:

- Late tenders are not opened

- Will only be considered if no other acceptable tender is received

Opening of tenders:

- Opened in public (if not, insist for a reason why this was not done)

- Name and prices are read out (if not, insist for a reason why this was not done)

“All things still being equal, the award shall be decided by the drawing of lots”

Payment for supplies and services

9.15 TENDER CLOSING

Ensure you deliver the Tender ON TIME.

If the closing time is 12 noon, your tender will be disqualified if it is handed in at one minute

past 12.

Negotiation Meeting:

Short listing:

- Has to be stated in Tender Document (legal)

- High value, complex, strategic projects (example. Intellectual property)

- Deliverables and timeframe unclear

Interviewing:

- Strictly individual, except in formation of consortium (example, machinery)

- Ensure you make contact to ascertain what the context of the meeting will be prior

to meeting

- Formal and minute. Chaired by senior management

TENDERS 81

- Come prepared with relevant documents

- Can be accompanied by financial / legal representative

9.16 AWARDING TENDERS

Historically awarded to lowest price:

- Does not necessarily reflect value for money

Awarded on:

- Price; and

- Point scoring system

Points can be awarded for:

- Use of local resources

- Use of SMME’s

- Generation of employment

- Equity shareholding

- Affirmative action principles

- Financial Stability

Ensure that you have “value-ads” clearly indicated in your final document.

This could sway a decision your way!

9.17 TENDER REJECTION

You have the right to request the reasons for rejection – Promotion of Access to Information Act,

2000

Factor Weight Comments Score Total Comments Score Total

Price 1 0 0

Empowerment 2 0 0

Own Equipment 3 0 0

Delivery schedule 4 0 0

Training Material 1 0 0

Maintenance Support 2 0 0

TOTALS 0 0

VENDOR 1 VENDOR 2EVALUATION CRITERIA

TENDERS 82

9.18 ADVICE FROM SEDA

Effort assures tender success

Failing to secure a tender, especially after numerous attempts, often illicits cries of corruption from

business owners. But business owners frequently lose sight of the fact that experience is vital in

winning a contract and that procurement officers would rather give their business to a company

that has done a lot of the kind of work they require than one with little or no experience.

Judy Stevens, owner of building and construction company Bright Ideas Projects, says she sent

more than 20 applications to government departments and private companies, but failed to secure

a single tender. Stevens said she paid about R200 for each tender document.

The procurement officials told her the applications were turned down because her Construction

Industry Development Board (CIDB) grading was too low.

Ricardo Persens, an Umsobomvu Youth Fund tender training advisor, says some companies

require for you to have done work of a similar value to what you are tendering for before

granting you the job. He says this is the case in the construction sector where the CIBD grades

you according to the value of work you have done.

But this does not satisfy Stevens. “How am I going to improve my CIDB grading if I don’t get an

opportunity to do jobs?”

Trevor Delcarme owner of Delcor Gardening Services, says he has applied for about five

tenders at government departments without success. Benito Hoop, office manager for Red Door

in Atlantis, says the reason Delcarme may not yet have been awarded a tender could be

because he does not have enough experience in his industry. Delcarme’s business has only

been in existence for a year.

Hoop says big businesses and parastatals such as Eskom require that all their suppliers have

been in business for a period of at least two years and that they have a credible track record.

Another problem could be that a business owner has neglected to take the time to get to know

the organisation for whom they intend tendering for.

Says Persens: “They will be able to judge from your pitch (tender application) whether you have

made the effort to familiarise yourself with their budgets or financial statements”.

He suggests business owners approach a third party, such as a business advisor, to look at

their tenders and to help them to put together a “good-looking pitch”. Persens says you do your

chances no good if you price incorrectly.

He says business owners must also have enough capital in reserve. Not having sufficient

finance available to complete a job could sink your chances of being awarded a contract.

He says it's for this reason that some procurement people insist on tenderers having a good

relationship with their bank so that they can have an overdraft facility to fall back on.

TENDERS 83

9.19 PRICING STRATEGIES

9.19.1 Types of Contracts

Cost Contracts

Cost plus Percentage of Cost. (CPPC).

Cost plus Fixed Fee (CPFF).

Cost plus Incentive Fee (CPIF).

Fixed Contracts

Fixed Price plus Incentive Fee (FPPI).

Firm Fixed Price (FFP).

Contract Risks:

Figure 16 – Contract Risks

However, there are many ways to price a product.

Let's have a look at some of them and try to understand the best policy/strategy in various

situations.

TENDERS 84

Pricing Strategy:

Figure 17 – Pricing Strategy

Premium Pricing

Use a high price where there is a uniqueness about the product or service. This approach is used

where a substantial competitive advantage exists. Such high prices are charge for luxuries such

as Cunard Cruises, Savoy Hotel rooms, and Concorde flights.

Penetration Pricing

The price charged for products and services is set artificially low in order to gain market share.

Once this is achieved, the price is increased.

Economy Pricing

This is a no frills low price. The cost of marketing and manufacture are kept at a minimum.

Supermarkets often have economy brands for soups, spaghetti, etc.

Price Skimming

Charge a high price because you have a substantial competitive advantage. However, the

advantage is not sustainable. The high price tends to attract new competitors into the market, and

the price inevitably falls due to increased supply. Manufacturers of digital watches used a

skimming approach in the 1970s.

Once other manufacturers were tempted into the market and the watches were produced at a

lower unit cost, other marketing strategies and pricing approaches are implemented.

Premium pricing, penetration pricing, economy pricing, and price skimming are the four main

pricing policies/strategies. They form the bases for the exercise.

However there are other important approaches to pricing.

TENDERS 85

Psychological Pricing

This approach is used when the marketer wants the consumer to respond on an emotional, rather

than rational basis. For example 'price point perspective' - 99 cents not one rand.

Product Line Pricing

Where there is a range of product or services the pricing reflect the benefits of parts of the range.

For example car washes. Basic wash could be R25, wash and wax R45, and the whole package

R65.

Optional Product Pricing

Companies will attempt to increase the amount customer spend once they start to buy. Optional

'extras' increase the overall price of the product or service. For example airlines will charge for

optional extras such as guaranteeing a window seat or reserving a row of seats next to each

other.

Captive Product Pricing

Where products have complements, companies will charge a premium price where the consumer

is captured. For example a razor manufacturer will charge a low price and recoup its margin (and

more) from the sale of the only design of blades which fit the razor.

Product Bundle Pricing

Here sellers combine several products in the same package. This also serves to move old stock.

Videos and CDs are often sold using the bundle approach.

Promotional Pricing

Pricing to promote a product is a very common application. There are many examples of

promotional pricing including approaches such as BOGOF (Buy One Get One Free).

Geographical Pricing

Geographical pricing is evident where there are variations in price in different parts of the world.

For example rarity value, or where shipping costs increase price.

Value Pricing

This approach is used where external factors such as recession or increased competition force

companies to provide 'value' products and services to retain sales e.g. value meals at McDonalds.

TENDERS 86

Here is a pricing strategy matrix that can help you find your just right pricing strategy4:

Low Price Medium Price High Price

High

Value

Underpriced: value

undercut by price. "What's

wrong with this picture"

pricing strategy."

Attractive pricing: ideal for

market penetration. "More

for your money" pricing

strategy.

Premium pricing: prestige,

prominence.

"Connoisseur" pricing

strategy.

Medium

Value

True bargain: may be a

temporary special to raise

revenue or to move

discontinued items.

"Inventory sale" strategy.

Price and value are in

balance, exclusive of

other factors. "Square

deal" pricing strategy.

Overpriced: informed

buyers will stay away;

sales may be made to

unsophisticated market.

"Infomercial" pricing

strategy.

Low

Value

Cheap stuff. Often sold

with lots of "bonus" items

or features. "Tourist trap"

pricing strategy.

Turns sales into

complaints. "Caveat

emptor" pricing strategy.

("Let the buyer beware.")

Don't even think about it:

the "Fleece 'em and run"

pricing strategy

Figure 18 – Pricing Matrix

Remember:

Some products or services can be delivered at a fixed cost while others call for an estimated cost. Examples of costs that are usually fixed are:

Rent .

Salaries.

Subscriptions.

Vehicle leases.

Stationery.

Estimated cost requires an educated guess based on the following:

Quantities of material needed.

Length of time to completion.

Insurance needed.

Depreciation of vehicles and equipment over the course of the contract.

Indirect costs.

4 Molly Gordon

TENDERS 87

It is important to note that some costs are variable and that they may fluctuate as production

fluctuates:

Labour .

Materials .

Equipment .

Internal factors that will impact on pricing decisions in relation to the profitability of the tender

must be identified in time before a fixed price is quoted. Internal factors that can have an influence

on the price are matters such as:

Illness of key personnel

Worker unrest and strikes

Equipment breakdown and replacement costs

Theft of production material

Lack of motivation and low productivity.

External factors that need to be considered:

Subcontractor or tender partner performance in case of a JV. If your tender partner fails

to perform, you fail to perform.

Worker unrest and strikes at your supplier companies.

Weather conditions in case of construction works.

Increase in the price of materials where it is imported as a result of exchange control etc.

Unavailability of raw material from your suppliers resulting in loss in production.

Rate increase in case of borrowed money.

The following are also important considerations:

Will the requestor be making interim payments (so that your business maintains cash-flow

and can pay the weekly salaries, materials and so on)? This is especially important for

lengthy contracts.

Will you require bridging finance? If so, do you have security for a loan?

If you will need to borrow money to perform the contract, you should do the groundwork while you

are preparing the tender. Then if you win the contract, you will be able to get a loan so much more

quickly

9.19.2 Finding the break-even point

The break-even point can also be described as “the margin of safety”. It is a term that is used to

describe the difference between a dangerous situation and being safe.

TENDERS 88

Variations in pricing decisions are to be calculated in terms of the impact on the break-even point

and in the world of finance this represents the point where you will make neither a profit nor a

loss. You will break-even. The objective of doing business is to make profit and not to just break-

even.

You must however have a clear understanding of the break-even point by taking into

consideration all the cost factors mentioned above in order to be safe when making the final price.

Break-Even Analysis:

Figure 19 – Break-even Analysis

Break-Even Formulas

Break-Even Volumes in Units

=

FIXED EXPENSES .

CONTRIBUTION MARGIN PER UNIT

Break-Even Volumes in Value

=

FIXED EXPENSES

CONTRIBUTION MARGIN RATIO

It is wise to review costing and pricing methods to ensure correct application to tender

specifications prior to submission of the tender. Once the tender has been awarded you are liable

to deliver the goods at the price tendered.

Price your business into the marketplace- Advice from Seda

Offering a low price for your product or service in the marketplace is not always the wisest way

to compete.

In fact, it may even kill your business as competitors with bigger buying power could easily

charge less than your small growing business. And if they start a price war there’s little chance

that you as a smaller business will survive.

Paul Netto (pictured here), who runs Tinta Paints, a paint manufacturing and distribution

business, says discounting your product to move more stock won’t necessarily increase your

bottom line.

O

R

Q

PROFIT

SALES

TOTAL COSTS

VARIABLE COSTS

FIXED COSTS

BREAK EVEN

LOSS

TENDERS 89

“Nine times out of 10 you’re doing yourself an injustice by discounting,” explains Netto, who

learned the hard way when he discounted his paint prices by 20% in order to sell more

products.

In his case he ended up doubling his sales, but his gross profit only increased by a mere four

percent. The answer, he says, lies in rather adding more value to the product you are selling.

He does this by guaranteeing the customer a consistent product and by offering them excellent

service. He also markets his product inside his customers’ stores by supplying them with

additional help such as colour charts of his paints.

Netto says when he first secured an agreement with a local hardware chain a few years ago, he

discounted his paint for them to below cost price. After a year, he informed the hardware chain

that he was pushing up his price by 12%.

This was above the eight percent increase that other manufacturers were offering. But he told

the client upfront that he would go out of business if he increased the price by any less. By then

he had built up such a good relationship with the client that they readily agreed to the price

increase.

When it comes to pricing, sales consultant Bill Gibson of Knowledge Brokers International says

business owners need to stick to the basic principles and factor in price margins.

Margins are not introduced just to make a profit, but could be:

To allow for error and unforeseen instances – such as a change in government policy.

To allow for a competitive entry into the marketplace if you’re the first to introduce the product or

service. This will allow you to later drop your prices and so gain an advantage over your

competitors in the industry.

But to encourage customers to buy, you could also price your product at, or below cost price and

make up the lost profit on add-on products or services. This is called loss leadership pricing.

An example would be a furniture retailer that sells a certain table at below cost price, but marks

up its prices on an associated product like chairs. You could then have in-store posters reminding

customers about the special you’re running on the add-on products. This is called “clipboard

selling”.

But Gibson says you need to be careful that you don’t mark up prices on other unrelated goods,

which would leave customers confused as to how you arrived at these prices.

When it comes to discounting prices, Gibson says business owners should only grant a discount

if they have clear reasons to do so, such as discounts on volume purchases, to close a deal or

on upfront cash payments.

TENDERS 90

He says when pricing products, you should also consider things such as:

Packaging – which can add value to a product to the extent that customers will be willing to pay

more for the product.

Match-selling – where you give a customer who buys items that go together a discount.

Full price selling – where such things as Value-added Tax (VAT), transport or petrol costs are all

factored in.

9.20 TENDER GLOSSARY

“Open tenders” Open calls for tenders, also called advertised tenders, are open to

all vendors or contractors who can guarantee performance

“Restricted tenders” Restricted calls for tenders, also called invited tenders, pre-

qualified, short-listed, or selective tenders, are only open to

selected pre-qualified vendors and contractors

“Statement of Works

(SOW)”

A document used in the systems development life cycle. An

organisation desiring to have work done (i.e. the prospective

customer) produces an SOW as part of a request for proposals.

Software vendors or service companies (prospective contractors)

respond with proposals. The SOW specifies requirements at a

very high level. Detailed requirements and pricing are usually

specified at a later stage

“Scope of Work” Work to be done in detail and the exact nature of the work to be

done

“Location of Work” Specifies the location where the work is to be performed and

where people will meet to perform the work

“Period of Performance” Specifies the allowable time for projects, such as start and finish

time, number of hours that can be billed per week or month, where

work is to be performed and anything else that relates to

scheduling

“Deliverables Schedule” Lists the specific deliverables, describing what is due and when

“Applicable Standards” Any industry specific standards that need to be adhered to in

fulfilling the contract

“Acceptance Criteria” Specifies how the buyer or receiver of goods will determine if the

product or service is acceptable, what criteria will be used to state

that the work is acceptable

“Special Requirements” Specifies any special hardware or software, specialised workforce

requirements, such as degrees or certifications for personnel,

travel requirements, and anything else not covered in the contract

specifics

TENDERS 91

“Request for Proposal

(RFP)”

An invitation for suppliers, often through a tendering process, to

submit a proposal in a specific commodity or service. A tendering

process is one of the best methods for leveraging a company’s

negotiating ability and purchasing power with suppliers.

PS: RFP is sometimes used for a Request for Pricing

“Request for Quotation

(RFQ)”

Used where discussions aren't required with tenderers (mainly

when the specifications of a product or service are already

known), and price is the main or only factor in selecting the

successful tendererr. RFQ may also be used as a step prior to

going to a full-blown RFP to determine general price ranges. In

this scenario, products, services or suppliers may be selected

from the RFQ results to bring in to further research in order to write

a more fully fleshed out RFP

“Request for Information

(RFI)”

Proposal requested from a potential seller or a service provider to

determine what products and services are potentially available in

the marketplace to meet a buyer's needs and to know the

capability of a seller in terms of offerings and strengths of the

seller. RFIs are commonly used on major procurements, where a

requirement could potentially be met through several alternate

means. An RFI, however, is not an invitation to tender is not

binding on either the buyer or sellers, and may or may not lead to

an RFP or (RFQ)

Keep a good backup system

Keep record of success

Keep record of progress on contract implementation

MANAGEMENT CHECKS AND BALANCES – BUDGETS AND FORECASTS 92

10. MANAGEMENT CHECKS AND BALANCES – BUDGETS AND FORECASTS

As a business owner, the primary problem you face is a limited supply of resources, be it land,

labour, or capital, to accomplish your goals.

Allocating these scarce resources entails making many decisions. Specific decisions might

include:

If you are a farmer:

What should I grow this year?

How much fertilizer should I apply?

Should I replace my worn-out tractor?

If you are a manufacturer:

Should I develop a new product?

Do I need to replace the press this year?

Should I expand by purchasing or renting more factory space?

The answers to these questions could influence the profitability of your operation for years to

come. Or perhaps you need to decide how best to utilise your human resources, so that operators

do not sit idle, while maintenance work is being carried out.

Regardless of the scope of the issue being considered, you must sit down and analyse the

question. Budgeting does just that; budgeting coordinates resources, production, and

expenditures.

10.1 KEY OBJECTIVES OF BUDGETING

The goal of having a budget is to stay in control of your business’s finances in advance. Setting

the standard for your spending and revenue and having a tool to compare with actual will give

you the control that you need to stay profitable. At the very least it will give you an indication of

whether or not your business is actually profitable and not just busy.

A budget:

Provides detailed plans to aid the planning of annual operations.

Guides managers in their efforts to coordinate actions which are part of the general plan.

Communicates the policies and constraints to which departments and individuals are

expected to conform.

Provides a measurement tool by which managers are motivated to achieve.

Serves as a control measure against actual results to manage the exceptions.

Managers’ performance is often measured by their ability to meet budgeted objectives.


Budget definitions:

A budget is an estimation of the revenue and expenses over a specified future period of

time. A budget can be made for a person, a family or a group of people, a business,

government, country or multinational organisation or just about anything else that makes

and spends money. Budgets are a micro economic concept that show the trade off made

when one good is exchanged for another.

A budget is a financial plan which tells you both where you’re going and how you’re going

to get there. It gives you a goal, or destination (target profit) and maps out the route to get

there.

A budget is a numerical plan for allocating resources to specific activities. A budget does

not only deal with finances, but also with the allocation and utilisation of human, physical

and information resources, such as raw material, labour, office space, machine hours and

computer time.

A budget is a planning and control tool with which we can measure performance against

planned results.

“A budget is a financial plan that endeavours to predict the expected performance of the

business in financial terms… Without a budget, the planning and control of the enterprise’s

performance will be a hit and miss affair, and the annals of business history are littered

with stories of (businesses) which tried (to do without budgets) and failed”.5

A surplus budget means profits are anticipated.

A balanced budget means revenues are expected to equal expenses.

A deficit budget means expenses will exceed revenue.

Budgeting is implementing a business plan on paper before any resources are committed to

production; it helps you predict the consequences of an adjustment in your operation before ever

making the adjustment. While records serve as a record of the past, budgets are an anticipation

of the future. After budgets are done, they become a standard for monitoring what actually

happens in the operation.

Budgets are usually compiled and re-evaluated on a periodic basis. A budget is a tool that

managers use to translate future plans into quantities. Through budgeting, managers ensure that

they have the resources available to carry out the plans to reach the organisation’s goals.

Depending on the nature of the business, detailed plans may be formulated for the next few

months, the next year, the next 5 years, or even longer.

A budget is also a control mechanism. It:

Sets limits on the amount of resources that can be used by the business unit.

5 Eric Parker’s Road Map to Business Success, p.199


Acts as a benchmark to obtain the most productive and profitable use of the company’s

resources.

Is a continuous monitoring procedure, reviewing and evaluating performance with

reference to the previously established standards.

Therefore a manager needs a realistic understanding of the activities carried on by the business

unit and the company as a whole in order to establish standards. Arbitrary standards, set without

a basic understanding of the minimum costs as determined by the nature of the business unit’s

operations, can result in standards that are either impossibly high, or standards that are too lax.

If standards are unrealistically high, frustration and resentment will develop; if standards are too

lax, costs will spiral out of control, profits will suffer and morale will deteriorate. The budget

system of an organisation provides an integrated picture of the organisation’s operations as a

whole. It enables the manager of each business unit to see the relation of his/her part of the

enterprise to the totality of the company. Of course, the usefulness of a budget depends on the

reliability of the information used to create the budget. Unrealistic estimates of prices, yields, or

input quantities would lessen the accuracy of the budget and could possibly lead to a faulty

decision.

Sound management decisions can be made using budgets, but care must be exercised in using

only reliable information.

Adjustments are made to budgets based on the goals of the budgeting organisation. As you

conduct business during your budget year you should compare your actual income (revenue)

and spending (expenses, cost of sales, cash outflows, etc.) with what you estimated. This will

allow you to manage your spending so that you don't over spend and cut into or eliminate your

profits. You will also be able to see if sales have met expectations in order to cover expenses and

still remain profitable.

10.2 BUDGET PROCESS

Figure 20 – Planning Process

THE PLANNING PROCESS

1

Review past performance i.t.o

impact, effectiveness and

efficiency 2

Review and clarify vision,

mission, strategy and objectives

3

Prepare operational

plans, market analysis, sales

forecast4

Assess the resources needed

and estimate costs

5

Compile into draft budget.

Discuss, amend and finalise

budget

6Implement plans and

monitor impact costs and income


Budgeting Process

Figure 21 – Budgeting Process

Steps to follow:

Step 1: Communicate the long range plan

At the outset you need to establish what positive expectations – goals – you have for your

business and the plans you will put in place to help you reach those goals. Goal-setting is a critical

factor because without a target, there is nothing to aim for and little chance of anything being hit

or achieved.


A budget provides a good way of directing your business towards goals in terms of both expenses

and revenues. It gives a constant overview of costs incurred and revenues raised, which then

allows for the micro control of both of those elements.

Communicate your long-term plan to all concerned with drawing up budgets. Get the right people

involved from the start.

Internally, staff members with financial responsibilities should definitely have a role, as well as

those who head specific projects, and those accountable for devising sales targets and production

costs.

Step 2: Define the constraints of the budget

Historical information on sales and costs can be helpful in drawing up budgets, but it shouldn't

serve as your only guide. You must also consider what your future plans are and what your

competitive environment is apt to look like. Adjust your estimates, as needed, to reflect price

increases, inflation and other changing factors.

The organisation’s long-term planning is negatively affected by many factors, or constraints, of

which many are outside its control, such as:

Volatility and level of the currency - exchange rate.

The quality and location of infrastructure.

Lack of competition and investment opportunities.

Economic growth rate.

Salary and wage increases.

Sales growth.

Availability of resources, such as capital, or expertise.

Lack of credit.

Insufficient information.

Blackouts.

Port delays.

Traffic jams.

Step 3: Sales forecasts

The sales forecast gives the revenue target for the business. In conjunction with the sales force,

management forecast the sales and gauge their probability of happening. They would study the

size of the market in the past, determine if there is anything which will alter it this year, study the

competitors and any changes that are likely to affect sales.


Forecasting sales is the most difficult, most important part of any business plan:

How big is the overall market? Find out how many rands are being spent per year on your

product type(s) or services.

How many units are being purchased? Estimate the company's market share, or the

percentage of the total rands and units you will capture.

How are you advertising your product?

How many people will see your ad? Estimate the percentage of people that will become

purchasers as a result of your advertising.

Calculate units sold in the past.

What are the revenues and unit sales of your competitors? Once you know this, you can

figure your sales will be some percentage of this number.

How many salespeople will you hire, and how many units and rands can each one sell per

month? Calculate monthly revenues based on these sales projections.

Example6:

John Driver owns a golf supply retail store. John will use last year’s sales amounts to prepare his

cash flow budget for the next six months.

Here is the sales information from the first six months of last year:

January R18 000

February R18 500

March R20 500

April R28 900

May R32 300

June R36 600

John expects sales for this year to be 1 percent higher in the off season and 1.5 percent higher

during the golf season; which begins in April.

6 Adapted from CCH Business Owner’s Toolkit


John forecasts his sales for the first six months of this year to be as follows:

January R18 180

February R18 685

March R20 705

April R29 333

May R32 785

June R37 150

The company’s sales forecast probably won’t match actual sales because of the many variables

that ultimately affect the final amount. The economy, inflation, competitive influences, and a whole

range of other variables will affect actual sales. No matter how much uncertainty one associates

with these variables, however, a sales forecast is still an essential part of a business’s financial

management.

Step 4: Decide product mix/ service focus strategy

Too often, companies target the wrong products/ services with their marketing programmes, or

align resources and new product introductions in the least profitable segment.

To fully exploit product/ service mix, companies need to measure and control how fast each

product/ service or customer delivers profit to the business and then prioritise the products/

services that generate cash the fastest:

Compare profitability and cash contribution for a product line, market, territory, asset or

facility.

Identify the best products for market share growth initiatives.

Step 5: Draw up departmental budgets

In preparing the divisional or departmental budgets, heads of department must have an idea of

the executive and organisational goals and objectives. Once organisational goals and strategy

have been clarified and communicated, department heads can draw up their specific budgets.

They will identify their budget priorities in line with the business plan of the organisation.

They will determine both the long- and short-term needs of their division.

Some of the factors they will consider when planning their budgets are the following:

The number of personnel assigned.

Planned losses.

Leave schedules.


Unit operating schedule.

Scheduled regular overhaul.

Maintenance availability.

Scheduled inspections.

Training required?

Use of external contractors?

Availability of funding.

10.2.1 7Types of business budgets

From the diagram on a previous page, we can infer that one finds the following types of budgets

in a business:

Type of budget Focus Examples

Financial Cash flow

Cash flow budget

Capital budget

Balance sheet

Operational Operations

Sales budget

Income budget

Expenditure budget

Non-financial

Aspects of the

business not

expressed in financial

terms

Production budget in units

Sales volumes in units

Time projections of

projects

The Capital budget deals with big costs that you pay once to develop something, and how you

will pay for this; for example, putting in water pipes to a new township (municipality), or sinking a

new shaft (mining operation). The capital budget puts money aside for planned expenditure on

long-term purchases and big investments such as land, buildings, motor vehicles, equipment

and office furniture that will be an asset for more than a year - probably for many years to come.

For example, a municipality's capital budget will list the estimated costs of all items of a capital

nature such as the construction of roads, buildings and purchase of vehicles that are planned in

that budget year.

The Operating budget deals with the day-to-day costs and income to deliver services or make

a product; for example wages and maintenance work to keep the operations going.

7 Adapted from P.J Smit & GJ De J Cronjé, Management Principles, p.411


The operating budget lists the planned operating expenditure (costs) and income, for the delivery

of all services or products.

Operating expenditure is the cost of goods and services from which there will be short-term

benefit - that is, the services will be used up in less than one year. For example, the payment of

staff salaries results in a short-term benefit as salaried employees are paid monthly for one

month's work. They could resign, next month, and the organisation would not have the benefit of

their skills anymore.

Examples of operating costs are salaries, wages, repairs and maintenance, telephones, petrol,

stationery. Operating income is the amount received for services or goods delivered for a short-

term period.

For example, ratepayers pay rates monthly or annually as payment to their municipality for

receiving municipal services. Examples of operating income are property rates, service charges,

investment interest, and traffic fines.

The difference between the operating and capital budgets

A useful way to look at the difference between operating and capital expenditure is to think about

the purchase of a car. The purchase of a car is capital as the expected life of the motor vehicle

is much more than one year. The cost of fuel and repairs only provides short-term benefit (less

than a year) and therefore is operating expenditure.

The capital budget and operating budget have to be prepared and discussed together. This is

important because planned expenditure that is included in the capital budget will impact on the

operating costs and income needed to "operate" the organisation’s assets, efficiently.

This link between capital and operating budgets can be explained by using the car example again.

If you decide to buy a car, in addition to including funds for this in your capital budget, you are

going to have to include money in the operating budget for tyres, driver’s wages, petrol, service

and other operating expenses.

The increase in operating expenditure needs to be considered when making a decision on

whether or not to buy a new car. If fuel, tyres, repairs and wages costs cannot be included in the

operating budget because of insufficient funds to pay for them, then the business should not buy

the car!

Working (operating) capital

The business unit manager needs to list everything s/he needs to spend money on in order for

his/her business unit to operate. S/he needs to establish the cost of the equipment, furnishings,

fittings, etc. But this is not the end of it. To avoid running out of money before the business’s cash

flow will take care of ongoing expenses, s/he must make allowances for working capital.


The difference between investment capital and working capital

Investment capital is the amount of money one plans to spend on equipment and the fitting out

of one’s business premises.

Working capital is the money one needs to finance ongoing operations, e.g.:

The purchase of goods for resale, usually raw materials if one is a manufacturer, or stock

of finished items if one is a retailer.

Sundry business expenses like rent, utilities (telephone, water, electricity), salaries and

wages, vehicle operating costs.

Personal drawings to cover your living expenses.

Provisions for the payment of taxes and other statutory obligations.

Loan and vehicle instalments.

Working capital therefore refers to a business’s investment in short-term assets, such as cash,

short-term securities, accounts receivable and inventories (stock).

Net working capital is the excess of current assets over current liabilities. To calculate net

working capital, subtract current liabilities from current assets. The answer gives an indication of

the business’s ability to pay its short-term debts. The larger the amount of working capital, the

greater the chances that short-term creditors will be paid on time. The cash flow of a business

should take care of ongoing working capital needs.

When you assess your business unit’s working capital needs, keep the company policy to

extend credit to customers in mind. In the business-to-business sector, in particular, customers

will expect you to grant them credit.

Depending on the sector in which you are operating, terms can vary from 30 days to 120 days

and even longer!

To stay in business, you will have to pay out operating expenses, including rental and wages,

settle your suppliers’ accounts and draw living expenses.

To determine the amount of working capital a business has at hand at any given moment, you

freeze the business at a specific moment in time and draw up a balance sheet of the assets and

liabilities at that moment.

10.3 THE IMPORTANCE OF CONTROLLING WORKING CAPITAL

The control of working capital is at the heart of business management and is the key to the

profitability of every business unit.

A small business may minimise its investments in fixed assets by renting or leasing plants and

equipment, but it cannot avoid an investment in cash, receivables and inventories.


In contrast to putting money into fixed assets or investments, where there is normally a return in

the form of appreciation, interest or dividends, money put into working capital can produce

absolutely nothing- it can just be swallowed up.

That is why it is crucial that all employees are involved in the process of controlling working capital:

from managers to temporary staff.

The object is to ensure that the money tied up in working capital is kept to the absolute minimum

necessary to ensure the maximum number of sales and profits.

The relationship between sales growth and the need to finance current assets is close and direct.

It is therefore imperative that the financial manager stay aware of developments in the working

capital segment of his business, especially as continued sales increases will require additional

long-term assets, which will also need to be financed.

The balance sheet income statement process

Figure 22 – Balance Sheet Income Statement Process

The control of working capital is at the heart of business management and is the key to the

profitability of every business unit. A small business may minimise its investments in fixed assets

by renting or leasing plants and equipment, but it cannot avoid an investment in cash, receivables

and inventories.

SARS

Expenses BankCurrent Account

Salaries & Wages Cash Profit/Loss

Administarion

OWNERS EQUITY BORROWED Dividends

Sharecapital Loans

Retained Income- H P

Revaluationof Assets

Accounts Payable

Trade Creditors Accounts Receivable

Assets (Non Current Assets) Trade Debtors

Ground & Buidings

Plant & Machinery Cash

Motor Vehicles Sales

Computer Equipment

Office Machines

Office Equipment Work in Process

Inventory

(Stock) Sales Direct Labour

Direct Material

Fixed Assets Marketing Factory Expenses

Current Assets

Owners Equity

Long-term Loans

Current Liabilities

Income Statement


In contrast to putting money into fixed assets or investments, where there is normally a return in

the form of appreciation, interest or dividends, money put into working capital can produce

absolutely nothing- it can just be swallowed up.

That is why it is crucial that all employees are involved in the process of controlling working capital:

from managers to temporary staff. The object is to ensure that the money tied up in working

capital is kept to the absolute minimum necessary to ensure the maximum number of sales and

profits.The relationship between sales growth and the need to finance current assets is close and

direct.

It is therefore imperative that the financial manager stay aware of developments in the working

capital segment of his business, especially as continued sales increases will require additional

long-term assets, which will also need to be financed.

10.4 KEY AREAS FOR CONTROLLING WORKING CAPITAL

Figure 23 – Key areas for Controlling Working Capital

Purchasing

Current assets vary with sales, but the ratio of current assets to sales is a policy matter. If a firm

chooses to operate aggressively, it will hold relatively small stocks of current assets. This will

reduce the required level of investment and increase the expected rate of return on investment.

In such a case, it is important to purchase only the right amount to meet the demand. Unnecessary

or excess stock is capital tied up that cannot work elsewhere.

However, an aggressive policy like the one above also increases the possibility of running out of

cash or inventories, or of losing sales because of an excessively tough credit policy.

Production

Again, only produce to meet demand. Move materials through the production line as quickly as

possible, but again, be aware of the possibility that you could run out of product and not be able

to meet an increased demand.

EXPENSES CASH10

35 O/D

DEBTORS30

45

W I P30

45

STOCK30

45

FIXED ASSETS

100


Completed goods

Completed goods are dispatched to the customer immediately. There are only minimal stocks

waiting to be sold.

Just-in-time

JIT is based on reducing inventories (stock) to the absolute minimum. The flow of goods is

controlled by a pull approach; work is initiated only in response to customer orders. There are five

key elements for a successful JIT approach:

A company must rely on a few suppliers:

A focused factory incorporating a continuous flow line for a particular unit .

Setup time between different kinds of units must be kept to a minimum.

A company should strive for zero defects.

A multi-skilled and flexible work force that is capable of operating many different machines.

Credit control

Collect money efficiently and promptly from customers, while delaying payment to suppliers and

creditors as long as possible.

10.5 SUCCESSFUL BUDGETING

We cannot draw up a budget once a year and then put it in our bottom drawer, until the next

annual budget meeting comes around. Many managers just take out the old budget, dust it off

and add 10% to the previous year’s figures.

A budget needs to be monitored and controlled. It must be consulted regularly, so that corrective

action can be taken timeously if necessary.

For example, we get excited when there’s an increase in the demand for our product or service,

but a boom in sales does not necessarily mean good fortune if the manager has not looked at the

consequent effects throughout his/her business.

Even a 50% increase in sales revenue does not mean an automatic increase in profit, as the

manager might have spent extra on advertising to achieve the sales, or s/he might need to pay

overtime and purchase/rent extra transport as a result of increased volumes of production.

The fundamental steps to drawing up an effective budget are:

Construct.

Control.


Figure 24 – Drawing up a Budget

10.5.1 Constructing a budget

Budget preparation

Budget preparation is a dialogue between a manager and colleagues. There must be involvement

and participation to decide on the standards and whether a proposed budget is realistic.

Participation during this standard-setting process has the following advantages:

Realistic standards can be set.

It makes it harder for people to complain if the plan doesn’t work out and they have to alter

it.

Involvement from the start increases motivation and helps boost morale when things get

difficult.

Budgeting is an important part of delegation. If the manager gives people the discretion to make

their own decisions to achieve agreed goals, performance against budget is a fair method of

assessment.

Cash Flow

If we were able to do business in a perfect world, we'd probably like to have a cash inflow (a cash

sale) occur every time we experience a cash outflow (pay an expense). But we know all too well

that business takes place in the real world, and things just don't happen like that.

Instead, cash outflows and inflows occur at different times, and never actually occur together.

More often than not, cash inflows lag behind our cash outflows, leaving our business short of

money. Think of this money shortage as our cash flow gap. The cash flow gap represents an

excessive outflow of cash that may not be covered by a cash inflow for weeks, months, or even

years.

STOCK

DEBTORS

W I P

CASH

CREDITORS

Reduce / Increase

Quicker collectionSlower payment

Better Invoicing

Control expenses

Use – don’t abuse!


Managing cash flow allows us to narrow or completely close our cash flow gap. It does this by

examining the different items that affect the cash flow of the business. Examining cash inflows

and outflows, and looking at the different components that have a direct effect on cash flow, allows

us to answer the following questions:

How much cash does my business have?

How much cash does my business need to operate, and when is it needed?

Where does my business get its cash, and spend its cash?

How do my income and expenses affect the amount of cash I need to expand my

business?

If you can answer these questions, you're managing your cash flow!

A cash flow budget is a projection of your business's cash inflows and outflows over a certain

period of time. A typical cash flow budget predicts the anticipated cash receipts and

disbursements of a business on a month-to-month basis.

However, a cash flow budget could predict the cash inflows and outflows on a weekly or daily

basis. Because of the uncertainty involved in the cash flow budget, trying to project too far into

the future may prove to be less than worthwhile. At the same time, a cash flow budget that doesn't

look far enough into the future will not predict future events early enough for you to take corrective

action in your cash flow.

A six-month cash flow budget minimises the amount of uncertainty involved in the budget. It also

predicts future events early enough for you to take corrective action.

Preparing a cash flow budget involves four steps:

1. Preparing a sales forecast.

2. Projecting your anticipated cash inflows.

3. Projecting your anticipated cash outflows.

4. Putting the projections together to come up with your cash flow bottom line.

Step 1: Prepare a sales forecast

Revenue or sales forecasts are typically based on a combination of your sales history and how

effective you expect your future sales efforts to be.

Factor in how many products you expect to sell or the number of customers you expect to provide

a service to; the price you intend to charge for your products and/or services; and how much sales

will grow over time. Carefully consider your planned marketing efforts, your competitors, potential

demand for your product or service and the state of the local, regional and national economy.


Step 2: Determine sources of income/ anticipated cash inflows

Organisations must ensure that there will be adequate money to pay for their planned expenditure

if they are to "balance the budget". There are various sources of income that can be used to

finance expenditure

Main sources of capital budget financing:

1. External loans - External loans (from a bank or other financial institution) are an expensive

form of financing the capital budget because of the high interest rates in South Africa.

External loans should only be used to finance the purchase of major capital items such as

buildings and large equipment.

2. Internal loans - Many organisations have internal "savings funds" such as Capital

Development Funds or Consolidated Loan Funds. These funds can make internal loans to

the business unit or division for the purchase or development of capital items, usually at a

lower interest rate than for an external loan and the unit is paying the interest back to its

own "savings fund", which can later be used for another capital project.

3. Contributions from revenue - When purchasing a small capital item, the small total cost

can be paid for from the operating income in the year of purchase.

This financing source is known as "contributions from revenue". In most organisations,

this source of financing is used to pay for smaller capital items, such as one or two items

of furniture and equipment. As no interest is payable, this source of financing is

considerably cheaper than external or internal loans.

4. Government grants- Depending on the type of organisation, the government may award

certain grants, for example, municipalities may apply to national government for grants for

infrastructure development.

Donations and public contributions - Local and foreign donors may sometimes donate a

capital item or money to be used specifically for the purchase of a capital item, in a

disadvantaged area. They may want publicity for their donation, in which case the

organisation can arrange to acknowledge their sponsorship.

5. Investments- Capital can be raised by making shares available and/ or taking on partners.

Main sources of operational budget financing (this will depend on the type of business)

6. Sales – Retailers and manufacturers sell goods or services to the consumer at a certain

price to generate income/ revenue

7. Rates – Municipalities charge all people and businesses who own fixed property (land,

houses, factories, and office blocks) in the municipal area "Property Rates" - a yearly tax

based on the value of each property.


8. Service Charges / Tariffs - For specific services that can be directly charged to a person,

house or factory, the principle of "user pays" is adopted, for example, cellphone charges

or services such as water, electricity or approval of building plans; where the exact usage

of the service can be measured, to the person or business who actually used that service.

9. Fines -Traffic fines paid to the traffic department, late library book fines paid to the library

services, penalties for overdue payment of service charges, etc.

10. Budget allocations- The business unit is not directly involved in the selling and marketing

of goods or services and is allocated an operating budget from a central fund, usually under

the control of the Finance Department.

Step 3: Project your anticipated cash outflows

Projecting your cash outflows for your cash flow budget involves projecting your expenses and

other cash outflows over a certain period of time:

How much does it take to operate your phone line?

What is the cost of other utilities?

How about the cost of a company vehicle?

Do you need any supplies or inventory to operate your business?

How about any employee payroll, payroll taxes or independent product or service

providers?

Remember to include everything you spend money on to operate your business even if you

allocate some of the expenses to "petty cash" expenses, such as parking or bridge tolls while

travelling to see clients.

Projecting your expenses for the next month or six months may seem like a difficult task. You

may even feel like you're guessing when projecting some of your business unit's expenses as

there are a number of different variables that ultimately determine the amount of each expense,

for example, interest rates, the price of fuel, even the weather.

The cash outflows for every business can be classified into one of four possible categories of

cash outflows:

Costs of goods sold (cost of sales)

The cost of goods sold will include

Inventory (stock) purchases.

Shipping and handling.

Manufacturing costs.


Operating expenses

In the variable expense category, you will want to include the cost of raw materials or goods for

resale, if your business provides a product. If yours is a service business, your biggest variable

expense is likely to be the cost of labour.

Other examples of variable expenses are:

Sales commissions

Overtime.

Travel expenses.

Advertising.

Repair and maintenance.

Freight/ delivery expenses.

Capital expenses

Capital costs would include the purchase of computer equipment, vehicles, or other office

equipment.

When preparing a cash flow budget, you must predict the cash outflows for major purchases,

such as property or equipment, Major purchases are usually the result of a business expansion,

a business improvement, or a business replacement expenditure.

Cash outflows in this category are generally large and don't occur that often during your business

year.

Create an annual budget, in addition to a monthly budget, so you can identify any expenses

that you may have that come up only once or twice a year such as insurance and include them in

your list of expenses.

This allows you to amortise or spread the cost of this out over several months so that you can

plan ahead for the expense. As you work on your list of expenses keep in mind that these are

the expenses that are necessary to operate your business.

These should not be your "wish list" unless you want to budget in some expansion or growth. You

may want to create a budget with just the necessities and another version of your budget with

expansion expenses listed so that you can see the cost of both separately.


Step 4: Putting the projections together to come up with your cash flow bottom line

Month Feb March April May June July Total

A. Cash

balance/overdraft at

start of month

(2000) 1 000 8 700 7 100 8 600 (1 500)

Cash receipts:

Cash sales 12 000 16 000 20 000 18 000 14 000 14 000 94 000

Debtors 8 000 10 000 13 000 12 000 9 000 9 000 61 000

Loans - 5 000 5 000 - - - 10 000

Discounts - 1000 1000 1000 1000 1000 5 000

Investors 2 000 - - - 3 000 3 000 8 000

B. Total cash receipts 22 000 32 000 39 000 31 000 27 000 27 000 178 000

Cash payments

Fixed overheads 6 000 6 000 6 000 6 000 6 000 6 000 36 000

Variable expenses 1 000 1 300 1 600 1 500 1 100 1 100 7 600

Payments to suppliers:

Cash purchases 3 000 4 000 5 000 5 000 3 000 3 000 23 000

Trade accounts 9 000 13 000 13 000 15 000 12 000 12 000 74 000

Imports - - 4 000 - - - 4 000

Loan repayments - - - - 5 000 5 000 10 000

Purchases of fixed

assets

- - 8 000 - 10 000 - 18 000

Tax payments - - 3 000 - - - 3 000

Dividends - - - 2 000 - - 2 000

Other - - - - - 1 000

C. Total of cash

payments 19 000 24 300 40 600 29 500 37 100 28 100 178 600

D. Surplus or shortfall

(B-C or C-B) 3 000 7 700 (1 600) 1 500 (10100) (1100) (600)

E. Cash

balance/overdraft at end

of months

1 000 8 700 7 100 8 600 (1 500) (2 600)

The ending cash balance for the first month becomes the second month's beginning cash

balance. The second month's cash flow bottom line is determined by combining the beginning

cash balance with the second month’s anticipated cash inflows and cash outflows. The ending

cash balance for the second month then becomes the third month's beginning cash balance. This

process continues until the last month of the cash flow budget is completed.

A positive cash flow bottom line indicates your business has a cash surplus at the end of the

month.

A negative cash flow bottom line indicates that your business has run into a cash flow gap —

a period where cash outflows exceed cash inflows when combined with your beginning cash

balance.


If a cash flow gap is predicted early enough, you can take cash flow management steps to

ensure that your cash flow gap is closed, or at least narrowed. These steps might include:

Increasing your anticipated cash inflows from accounts receivable collections.

Decreasing your anticipated cash outflows by cutting back on inventory purchases or

cutting certain operating expenses.

Postponing a major purchase.

Looking to outside sources of cash, such as a short-term loan to fill the cash flow gap.

Pay your bills on time, but never pay your bills before they are due

The cash flow budget is an excellent tool to help you determine when or when not to make major

purchases. If your cash flow budget shows that additional funds may be available at a certain

point, this should provide you with the opportunity to make advance purchase decisions.

Planning ahead may allow you to take advantage of lower prices, discounts, or better financing

options. Likewise, if your cash flow budget shows that your cash supply might be a little tight, it's

probably not a good idea to make a major purchase, or take on an additional monthly loan

payment.

Points to remember when constructing budgets:

Don’t just add a certain percentage to last year’s figures. Circumstances may have

changed.

Be realistic. Don’t be over-optimistic, but don’t be too pessimistic either, so that you can

say you beat your budget.

Don’t deliberately pad your budget, generating unnecessary expenditure this year,

because you are afraid of future cut-backs.

Zero- Based Budgeting (ZBB)

Zero Based Budgeting refers to the process of preparing an operating plan or budget that starts

with no authorised funds. In a zero-based budget, each activity to be funded must be justified

every time a new budget is prepared.

Therefore all expenditures must be justified each new period, as opposed to only explaining the

amounts requested in excess of the previous period's funding.

For example, if an organisation uses ZBB, each department has to justify its funding every year.

That is, funding will have a base at zero. A department will have to show why its funding helps

the organisation efficiently toward its goals.

ZBB is especially encouraged for Government budgets because expenditures can easily run out

of control if it is automatically assumed what was spent last year must be spent again this year.


10.5.2 Controlling a budget

The three critical steps to controlling a budget:

1. Review actual performance

The frequency with which a manager monitors the budget and checks for variances differs: a

sales person or production supervisor usually checks his/her performance daily, while the

production or sales manager might check weekly.

Determine what caused the variance:

Have we lost orders?

Have we spent too much on raw materials?

Have we used more materials than we thought we would/

Have we spent too little or too much on promotion?

2. React to the variance

Variance analysis entails measuring actual performance against the standards and the

coordinated plan. A variance is the difference between budgeted and actual performance. A

deviation from the standard could be favourable or unfavourable, i.e. positive or negative.

React and report to everyone else who needs to know. If someone else has a variance, you need

to ask yourself what it means to your bit of the business. What corrective action do you need to

take?

A production variance occurs when a machine fails. If this is likely to cause a prolonged problem,

Production should let Marketing know, as Marketing might commit the business to orders which

cannot be filled, or spend money advertising products which cannot be delivered.

3. Revise the budget

A budget is not cast in stone. The manager needs to take appropriate action to either get the

original budget back on track, or revise the original budget commitment to take new facts into

account, depending on how significant the variance is.

Questions the manager would ask, are:

Should we reduce costs?

Should we increase promotional expenditure to continue to maintain sales?

Should we increase production to meet higher than expected sales figures?

Should Marketing cut back because Production can’t keep up?

Should the whole budget be revised to meet the new position?


Which are the questions I should be asking when I go back to the

business?

What is the ONE thing I can change immediately that will have the

most lasting and significant impact to my life and business?

GLOSSARY 114

11. GLOSSARY

Accounting

Equation

Assets = liabilities + owner's equity. The financial statement called the

balance sheet is based on the "accounting equation." Note that assets are on

the left-hand side of the equation and liabilities and equities are on the right-

hand side of the equation. Similarly, some balance sheets are presented so

that assets are on the left, liabilities and owner's equity are on the right.

Accounts

payable

Accounts payable are the unpaid bills of your business, the money you owe

to your suppliers and other vendors. Accounts payable are generally payable

within 30 days after receiving a bill from the supplier or vendor. "A/P" is the

standard abbreviation for accounts payable.

Accounts

receivable

Accounts receivable are monies owed to your business by your customers.

Any business that sells its products or services on credit will have accounts

receivable.

Accrual Method

of Accounting

With the accrual method, you record income when the sale occurs, not

necessarily when you receive payment. You record an expense when you

receive goods or services, even though you may not pay for them until later.

Assets

For accounting purposes, assets are the things your business owns. Assets

can be current (e.g., cash, accounts receivable, inventory and merchandise,

prepaid rent, prepaid insurance) or fixed (things that aren't held for resale

such as furniture and equipment, land and buildings). Assets are balance

sheet accounts: Assets = Liabilities + Owners' Equity.

Bad debts A bad debt is the account of a customer who purchased goods and services

on credit but who did not pay the amount due.

Balance Sheet

Also called a statement of financial position, a balance sheet is a financial

"snapshot" of your business at a given date in time. It lists your assets, your

liabilities and the difference between the two, which is your equity, or net

worth. The balance sheet is a real-life example of the accounting equation

because it shows that assets = liabilities + owner's equity.

Capital Money invested in the business by the owners. Also called equity.

Cost of Goods

Sold

The cost of goods sold is the total cost of all the goods sold to your customers

over a certain period of time. It is determined as a rule by taking total starting

inventory at the beginning of the period (usually a month), adding purchases

and deducting ending (end of period)inventory = cost of goods sold. The cost

of goods sold is subtracted from sales to determine the gross profit on an

income statement.

GLOSSARY 115

Credits

At least one component of every accounting transaction (journal entry) is a

credit amount. Credits increase liabilities and equity and decrease assets. For

this reason, you will sometimes see credits entered on the right-hand side

(the liability and equity side of the accounting equation) of a two-column

journal or ledger.

Current assets

Generally, current assets are cash or items that will be converted into cash

within a year. Some typical current assets are: cash; inventories of raw

materials; prepaid expenses such as rent, insurance and interest; and

receivables. The relationship between current assets and current liabilities

tends to show the business's ability to pay off its debt during the normal

course of operations. Current assets normally include cash, marketable

securities, accounts receivable and inventories.

Current

liabilities

Obligations that are due within one year are current liabilities. The

relationship between current assets and current liabilities tends to show the

business's ability to pay off its debt during the normal course of operations.

Current liabilities consist of accounts payable, short-term notes payable,

current maturities of long-term debt, accrued income taxes and other accrued

expenses (principally wages).

Debits

At least one component of every accounting transaction (journal entry) is a

debit amount. Debits increase assets and decrease liabilities and equity. For

this reason, you will sometimes see debits entered on the left-hand side (the

asset side of the accounting equation) of a two-column journal or ledger.

Depreciation

Depreciation is an annual write-off of the cost of fixed assets, such as vehicles

and equipment. For accounting purposes, depreciation is listed among the

expenses on the income statement.

Double-entry

Accounting

In double-entry accounting, every transaction has two journal entries: a debit

and a credit. Debits must always equal credits. Because debits equal credits,

double-entry accounting prevents some common bookkeeping errors. Errors

that do occur are easier to find. Double-entry accounting is the basis of a true

accounting system. In double-entry accounting, every transaction in your

business affects at least two accounts, since there is at least one debit and

one credit for each transaction. Usually, at least one of the accounts is a

balance sheet account. Entries that are not made to a balance sheet account

are made to an income or expense account. Income and expenses affect the

net profit of the business, which ultimately affects owner's equity. Each

transaction (journal entry) is a real-life example of the accounting equation

(assets = liabilities + owner's equity).

GLOSSARY 116

Equity

Equity is the interest or investment that the owners have in the business. The

amount of owners' equity is equal to the value of the business's assets, minus

the value of its liabilities. Equity is also referred to as net worth, owner's

equity or capital. Equity is the net worth of your company. Equity comes from

investment in the business by the owners, plus accumulated net profits of the

business that have not been paid out to the owners. It essentially represents

amounts owed to the owners. Equity accounts are balance sheet accounts.

Fixed assets

Fixed assets are used to facilitate your business's operations and are not held

for resale. Inventory held for resale, therefore, is not a fixed asset. Generally,

fixed assets may be both tangible and intangible. Tangible fixed assets include

furniture, fixtures, tools, equipment, vehicles and buildings. The asset may

be real or personal property. Intangible fixed assets consist of such things as

copyrights, patents, licenses, franchises, leases, subscription lists and

goodwill. A fixed asset may deteriorate over a period of time (vehicle), or last

indefinitely (land).

Fixed costs or

charges

Fixed costs or charges include such items as rent or depreciation on plant and

equipment items, property taxes and salaries of executive or management

personnel (who cannot be laid off because they are needed even during slack

periods). Fixed costs do not respond to changes in your business's activity.

These are bills you incur regardless of revenue and are at a fixed rate. For

example, your rent stays at the same rate whether you have five or 500

paying customers.

Income

Statement

Also called a profit and loss statement or a "P&L." It lists your income,

expenses and net profit (or loss). The net profit (or loss) is equal to your

income minus your expenses.

Interest

expense

When you borrow money or buy something on credit, you will be charged

"interest." This is a premium you must pay for the use of another's capital.

Interest is generally expressed as a certain percentage of the principal, per

year. As you pay off a loan, a portion of each payment goes toward

decreasing the principal (the rand amount borrowed) and a portion goes

toward paying off interest. The portion that goes to pay off the interest is the

"interest expense."

Inventory

Inventory is goods held for sale to customers. Inventory can be merchandise

bought for resale, or it can be merchandise manufactured or processed by a

business, in which the end product is sold to the customer

Liabilities

Liabilities are what your company owes. For accounting purposes, current

liabilities are those that are due within a year, such as accounts payable,

taxes and wages. Fixed liabilities (or long-term liabilities) are those that are

due in more than one year, such as notes payable that have a five-year

maturity. Liabilities are balance sheet accounts. Examples are accounts

payable, payroll taxes payable and loans payable.

GLOSSARY 117

Liquidity Liquidity refers to how quickly you can turn other assets into cash.

Long-term

Liabilities

Liabilities that are not due within one year. An example would be a mortgage

payable.

Net Income

Also called profit or net profit, it is equal to income minus expenses. Net income

is the bottom line of the income statement (also called the profit and loss

statement).

Net worth "Net worth" is how much your company is worth and is computed by

subtracting liabilities from assets.

Operating

income

Operating income is the sales income remaining after cost of goods sold, selling

expenses and general and administrative expenses have been subtracted, but

before interest expenses, taxes and any investment income or expenses have

been factored in.

Prepaid

Expenses

Amounts you have paid in advance to a vendor or creditor for goods or services.

A prepaid expense is actually an asset of your business because your vendor

or supplier owes you the goods or services. An example would be the unexpired

portion of an annual insurance premium.

Prepaid Income

Also called unearned revenue, it represents money you have received in

advance of providing a service to your customer. Prepaid income is actually a

liability of your business because you still owe the service to the customer. An

example would be an advance payment to you for some consulting services

you will be performing in the future.

Profit and Loss

Statement

Also called an income statement or "P&L." It lists your income, expenses and

net profit (or loss). The net profit (or loss) is equal to your income minus your

expenses.

Quick current

assets

The value of your business's quick current assets is the sum of its cash, net

receivables and marketable securities.

Retained

Earnings

Profits of the business that have not been paid to the owners; profits that have

been "retained" in the business. Retained earnings is an "equity" account that

is presented on the balance sheet and on the statement of changes in owners'

equity.

Trial Balance

A trial balance is prepared at the end of an accounting period by adding up all

the account balances in your general ledger. The debit balances should equal

the credit balances.

Unearned

Revenue

Also called prepaid income, it represents money you have received in advance

of providing a service to your customer. It is actually a liability of your business

because you still owe the service to the customer. An example would be an

advance payment to you for some consulting services you will be performing

in the future.

Working capital Your working capital is the difference between your current assets and current

liabilities. Working capital can be assessed by looking at your quick ratio.

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