Financial Management



              Personnel Management   Business Description




Financial Management                ...
BIZBITE CONSULTING GROUP


                       Financial Management



Every effort was made to ensure that these mater...
T of Contents
 able
      A. Introduction to Financial                              1. Monthly Financial
      Management ...
BizBite Disclaimer

The personal experience of the author forms the bases for this material.
BizBite Consulting Group (kno...
Credit Page

The founders of BizBite Consulting Group and developers of BizBite's
dynamic approach to business education a...
Table of Contents

          Major Headings                        Sub Headings

A. Introduction Financial             Pla...
A. Introduction to Financial Management




Introduction

There are two parts to the introduction Financial Management

1....
1. Planning For Business Success
Introduction

The term financial management of a business means managing the invested
mon...
We designed Financial Management for managers regardless of their
background or training.
   The intent here is not to tra...
It is important for any business to use historical financial statements for
reference and guidance in preparing financial ...
Types of business financial data

Business financial data and reports are tools that keep you on the right track
when mana...
Financial Management will discuss in some detail operational methods, ideas,
and tools that you will use on a daily basis ...
2. Financial Data—the Heart of the Business
            "Wherever you see a successful business, someone once made a
     ...
How to use this information

Financial data will explain the basic business reports necessary to run any
business. The pur...
Business reports

Your business needs a specially designed accounting system. However, there is
essential reporting that e...
The two key financial statements that convey this information are
1.    The income statement (also called the profit & los...
The capital equipment list can be very simple and should include columns to
record the following information:
            ...
Capital Equipment Record
Asset Group:                  Equipment #:               ___ Record Date:         ____

Location:...
Maintenance/Repair Record

  Date     Maintenance/Repair          Vendor         Cost      GST   PST   Total
             ...
Capital Expenditure Request
                                 [Company Name]

ACE.#                                        ...
Approved by: ____________________________________________________________
                                      [Title]
Ap...
This Capital Expenditure Request Form is included as an example of how to
use a company internal document to justify the n...
Celebrate!!




     Financial Management ©   17
B. Financial Analysis of Operations




Introduction

In Financial Analysis of Operations, we will discuss three basic com...
(1)   Job costing analysis preparation

Job Costing Analysis Preparation presents in detail the steps any business
would t...
(3)   Break-even point (BEP) analysis

The material discusses break-even point (BEP) analysis and the uses of
various ways...
1. Job Costing Analysis Preparation
Introduction

It is important for every business to determine accurately its fixed cos...
The job costing process


   The job costing process has six steps:
          1. Research fixed costs
          2. Determi...
Step #2—Determine revenue necessary to offset fixed costs

The second step is to express the total of the fixed costs in t...
Step #3—Calculating employee charge rate to recover costs

Now, calculate the basic recovery charge-out rate for every emp...
Step #4—Segmenting services

Segment all service components provided by the business. In the case of this
example, a compa...
Each year, review the project history so that any necessary adjustments are
made to this factor.

Step #5—Analyzing employ...
How does this compare to the projected operating costs for the company that
we estimated in step #2?
   Recover the total ...
Summary

In Job Costing Analysis Preparation, we have demonstrated how to calculate
a job costing analysis for a business....
Celebrate!




             Anyone for a
             little surfing?




     Financial Management ©    29
2. Financial Feasibility Study of the Business's Offerings
Introduction

Whether it is a new business or an existing busin...
How to use this information

Assume that you have already made tentative decisions about what offerings
the business will ...
The analyzing process

Use this analyzing process to determine if it is financially doable to sell the
offerings
        T...
The five market segments in this example are retail, commercial, industrial,
government and institutional.
        The vol...
As you can see from this simple example, the relationship between market
segments can be complex and have many variable fa...
Summary

In Financial Feasibility Study of the Business' Offering, we had discussed
the process of determining what the ta...
Celebrate!!




     Financial Management ©   36
3. Break-even Point (BEP) Analysis
Introduction to break-even point (BEP) analysis

The break-even point (BEP) analysis is...
A break-even point (BEP) analysis can evaluate possible prices.

Express the objective in dollars or units of product. A b...
How to use this information

Some of the figures you need to calculate the break-even point (BEP) will have
to be estimate...
The methodology is valid in either a fee-for-service business with no
   inventory or a business selling offerings. Howeve...
Take the same approach within a department in order to assign costs to a
particular major offering group or a special proj...
Variation of the break-even point (BEP) analysis

Considering all the variable costs can require detailed analysis and ver...
Then, based on this historical information and actual percentage to sales
relationships of expense items, you can estimate...
Example 2
You need the number of customers per day for a break-even point (BEP). There
may be hundreds of items, all at di...
(2)    Profit planning formula

The break-even analysis can be adapted to profit planning by simply altering
the formula s...
2.     Let us assume that the owners of the business in Example #1 feel that they
       should earn a 10% return because ...
The formula presented here is useful in maintaining selling prices at levels
consistent with the levels of GM percentage y...
Points to consider when using break-even analysis and related formulae
        The break-even point (BEP) analysis does no...
Uses of the break-even point (BEP) analysis

The break-even point (BEP) analysis can to be used to:
        Evaluate possi...
Celebrate!!




     Financial Management ©   50
C. Operational Financial Management




Introduction

In Operational Financial Management, the focus will be on the follow...
1. Inventory management

In Inventory Management, you will learn the different ways in which
inventory is evaluated. Sampl...
3. Preparing pro-forma cash flow statements

In Preparing Pro-forma Cash Flow Statements, we will present in detail the
el...
1. Inventory Management
Introduction

For any company that handles inventory, the inventory represents a major
investment ...
a. Inventory evaluation

Evaluation of the inventory can vary with the industry and the type of business.
   Natural resou...
(1)    First In first out (FIFO)

The FIFO method of inventory evaluation assumes that:
      The first items (purchase fo...
(3)    Weighted average

The weighted average method of inventory evaluation assumes that:
      Unit cost of inventory is...
(4) Periodic and perpetual inventories

The inventory calculation examples (shown above) assume that on a periodic
basis, ...
Managing the product mix in inventory

The product mix is a term that refers to the product selection that a company
stock...
b. Inventory investment

Being constantly aware of the amount of money necessary to maintain
established inventory levels ...
Based on the inventory reports, you need to budget money for monthly
maintenance of the inventory investment in each produ...
(1)   Inventory identification

Identify every item in inventory needs as to:
        An inventory ID number
        When ...
Clerks using a product code like this become very proficient at reading the code
without any hesitation. It becomes second...
Producing inventory movement reports at the push of a button on your
computer works well in getting a global picture of th...
Once you have assigned a time limit to the inventory, use a visual method
similar to that previous discussed to identify i...
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Finamcial Management
Upcoming SlideShare
Loading in …5
×

Finamcial Management

1,846 views

Published on

Published in: Economy & Finance, Business
0 Comments
2 Likes
Statistics
Notes
  • Be the first to comment

No Downloads
Views
Total views
1,846
On SlideShare
0
From Embeds
0
Number of Embeds
2
Actions
Shares
0
Downloads
90
Comments
0
Likes
2
Embeds 0
No embeds

No notes for slide

Finamcial Management

  1. 1. Financial Management Personnel Management Business Description Financial Management Goals and Outcomes Sales & Marketing Management Business Offerings
  2. 2. BIZBITE CONSULTING GROUP Financial Management Every effort was made to ensure that these materials comply with the requirements of copyright clearances and appropriate credits. BizBite Consulting Group will attempt to incorporate in future printings any corrections communicated to it. Copyright 2003, 2004 BizBite Consulting Group A division of CorNu Enterprise 1412-621 Discovery Street Victoria, BC V8W 2X2 All Rights Reserved Printed in Canada
  3. 3. T of Contents able A. Introduction to Financial 1. Monthly Financial Management .................................. 1 Performance Review and Analysis .................................. 131 1. Planning For Business Success........................................ 2 2. Income Statement Analysis 139 2. Financial Data—the Heart of the Business ........................... 7 3. Balance Sheet Analysis . 154 B. Financial Analysis of 4. Testing the Financial Operations ................................... 18 Strength of Your Business.... 162 1. Job Costing Analysis E. Financing, & Risk Preparation.............................. 21 Management, Business Planning 196 2. Financial Feasibility Study of the Business's Offerings ..... 30 1. A Guide to Finance ....... 199 3. Break-even Point (BEP) 2. Risk Management Analysis .................................... 37 Strategies................................ 209 C. Operational Financial 3. Business Plan Format Management ................................ 51 Sample.................................... 223 1. Inventory Management .. 54 Summary of Financial Management .............................. 231 2. Accounts Receivable (AR) and Credit Policy..................... 75 Glossary ................................. 234 3. Preparing Pro-forma Cash Flow Statements .................... 112 D. Monitoring the Financial Health of the Business............... 127 . i
  4. 4. BizBite Disclaimer The personal experience of the author forms the bases for this material. BizBite Consulting Group (known as BizBite) makes no representations or warranties regarding the use of this material in whole or in part and assumes no liability for any claims, losses, or damages arising from the use of the material. The use of this material (in any way) should not be construed as taking professional advice from the author or BizBite. Protection of Copyright This material is the intellectual property of BizBite, a partnership registered in the province of British Columbia, Canada. International copyright law protects it. The purchasers of this material may only use it for their personal use or, as a training tool, within their business. It is illegal to copy, modify, or transfer this material, any other BizBite materials, or BizBite may authorize any documentation pertaining to it except as in advance. Any modification or merged portion of this or any other BizBite course, in whole or in part, is prohibited except as authorized in advance by BizBite. If you transfer possession of any copy, modification, or merged portions of any BizBite materials without authorization, you may be liable for prosecution and BizBite may take legal action against you and/or your company. ii
  5. 5. Credit Page The founders of BizBite Consulting Group and developers of BizBite's dynamic approach to business education are: Graeme Robertson and Dr. Shirley Chapman The following people contributed to this document: Content Specialist J. Graeme Robertson Graeme Robertson is a seasoned business management professional with over 30 years of experience. He has held senior positions in retail, wholesale, and distribution operations. Additionally, Mr. Robertson was Regional Manager for a national personnel/consulting firm and he has been actively engaged in business management consulting for over 20 years. Designer and Developer Dr. Shirley Chapman B. Ed. M.Ed. Ph.D. Dr. Shirley Chapman is a veteran educator with over 30 years of experience. She is an expert in course/program design and development. Her experience covers public schools, colleges, and universities. Shirley is experienced in designing and developing training specifically for delivery via face-to-face, on-line (Internet), and manuals for organizations, colleges, and businesses. She is responsible for the page layout and format as well as the graphics in any materials that she designs. Proofreader—Precision Proofreading—Deborah Wright edit@preproof.bc.ca http://www.preproof.bc.ca iii
  6. 6. Table of Contents Major Headings Sub Headings A. Introduction Financial Planning for Business Success Management Financial Data—the heart of the business B. Financial Analysis of Operations Job costing analysis preparation Financial feasibility study of the business' offering Break-even point (BEP) analysis C. Operational Financial Inventory management Management Accounts receivable & credit policy Preparing pro-forma cash flow statements D. Monitoring the Financial Health Monthly financial performance of the Business review and analysis Income statement analysis Balance sheet analysis Testing the financial strength of your business E. Consideration in Financing, A guide to finance Business Planning, and Risk Business plan format sample Management Risk management strategy Glossary of Terms iv
  7. 7. A. Introduction to Financial Management Introduction There are two parts to the introduction Financial Management 1. Planning For Business Success 2. Financial Data—the Heart of the Business Financial Management © 1
  8. 8. 1. Planning For Business Success Introduction The term financial management of a business means managing the invested money in the business. The invested money in any business will include: Physical assets—such as facilities, furniture, equipment, machinery, or fixtures These assets allow the business to function in a physical location. Working capital—invested in inventory, intellectual property, delivering services. The business revenue manages inventory, uses intellectual property, and delivers services in the process of earning for the business. How well the business manages the money invested in the business determines: How profitable the business will be The return on investment (ROI) money to the owners The long-term success of the business The focus of Financial Management will be operational. That is, it will focus on what managers need to pay attention to on a daily and monthly basis to be good managers of the money invested in the business. Many business managers assumed their positions without having formal training in business, accounting, or finance. Financial Management © 2
  9. 9. We designed Financial Management for managers regardless of their background or training. The intent here is not to train you to be an accountant but to introduce you to ideas and methods of financial management and controls that will help your business. For example: Financial management concepts Financial management methodologies How to apply some common financial management methods How to use and interpret financial information Some options and approaches that may be applicable to your business Questions you should ask of your accountant As well, this material will assist small businesspeople to: Ask better questions of their accountant Be better able to interpret the financial reporting their accountant provides Make better business management decisions How to use Financial Management When you completed the internal business plan for your company, the final step was to prepare detailed financial projections. These financial projections show financial information related to the execution of the marketing plan but includes all of the fixed and variable costs of your business. Your accountant may have assisted you to complete this. Financial Management will help you to do a better job of preparing some of the information for your accountant. It will help you to analyze and interpret the results. Financial Management © 3
  10. 10. It is important for any business to use historical financial statements for reference and guidance in preparing financial projections. It is essential that the business owners refer frequently (at least monthly) to the company's business plan by comparing the pro forma reports to the current actual reports (supplied by the accountant) so make the inevitable adjustments. This financial data provides a financial picture of where the business is as of the date of the reports and where the business expects to be at various time intervals in the future. More detail is provided in the section Financial Data— The Heart of the Business. Additionally, there are a number of other reporting tools, methods, and procedures that are useful to the manager monitoring the business's financial health. We introduced several of these along with their uses and application. Compare this information to the way that you presently operate your business. We recommend that you refer to your business plan at least quarterly. It is not as likely that the business will stray too far from the predicted path in less than a quarter. However, the exception to this would be if the company was making a big change in its direction involving things such as: Completely new business style A new division of the company Introduction of major new offerings or perhaps the discontinuation of traditional offerings A radical change in advertising and marketing the company Any change that has the potential for a major impact on the company (ether positively or negatively) is cause for a frequent reference to the business plan as well as checking how any changes affect the use of the money invested in the business. This is financial management of the business. Financial Management © 4
  11. 11. Types of business financial data Business financial data and reports are tools that keep you on the right track when managing your business. Broadly speaking the data and reports fall into three categories: Planning and organizational tools Operational tools Summary and analysis tools The financial data included in the internal business plan is of a planning and organizational nature. It should show where your business is now and where the business expects to be at intervals in the future. An internal business plan does not usually demand as much detail as the external business plan that is also a planning and organizational tool designed for presentation to a lender. Nevertheless, the financial information in your business plan should include: Current audited financial statements if it is an existing business. A 3-year financial projection, first year by quarters, or remaining years annually The projection should include: Pro-forma income statements (sometimes called operating statements) Balance sheets Cash flow statement Capital expenditure estimates Projection of any project Current development costs such as: Consulting fees Packaging design Manufacturing Design and preparation of marketing materials Explanation of the use of any investment funds and the expected results from the application of those funds Financial Management © 5
  12. 12. Financial Management will discuss in some detail operational methods, ideas, and tools that you will use on a daily basis in the financial management of your business. It also will talk about summary and analysis tools, and the financial reports that you will use to measure and monitor the performance of your business. Summary The foregoing is only a general outline and overview of the purpose and use of financial data. Many business owners will require professional help in preparing, organizing, and interpreting their financial data. We strongly recommend this. To be effective and relevant, review financial data regularly. Complete it in an organized way. Prepare a format—a schedule for reviewing financial information: Monthly Quarterly Annually This material offers suggestions. Discuss with your accountant what an appropriate review and analysis schedule would be for your business. Laws of Business—on organization A business organization is a group of people brought together for the sole purpose of creating and keeping customers. Again, the main purpose overrides all else. Financial Management © 6
  13. 13. 2. Financial Data—the Heart of the Business "Wherever you see a successful business, someone once made a courageous decision."—Peter Drucker Introduction Before you turn a wheel, sell a widget, or accept a contract, it is essential that you decide how you will keep track of the business transactions. Good accounting for your business is important because of legal and tax requirements. A good accounting system provides you with the tools you need on a daily basis to take the pulse of your business and make the positive business decisions that will keep it healthy and on track. It should be tailored to your business needs and be simple enough so that it can be maintained on a daily basis. This is how you control your business, know where it has been, and know where it is going. Control is essential! If you don't control your business, your business will control you! If you don't have the training or experience to assess your needs and set up an adequate bookkeeping system, hire a competent, certified accountant to do it. It will be money well spent. Financial Management © 7
  14. 14. How to use this information Financial data will explain the basic business reports necessary to run any business. The purpose is to familiarize you with these reports and their function in managing the business. We will not attempt to do an in-depth analysis of the reports. You will learn some common definitions of terms found on financial statements. You will study some common tests for the financial health of the business—the tests that you should perform on a monthly basis. The intent is to increase your understanding of financial terms and enable the daily monitoring of business activities. Beyond this, you should consult with your certified accountant for in-depth clarification of actual business data. The new business owner will find this useful background information in working on the preparation of the Pro-forma financial statements. The information will help in dealing with your accountant in the set up of the business and in interpreting the reports, the accountant prepares for you. Besides, it will be useful in closely monitoring the start and on-going growth of the business. The existing business owner will likely have some level of knowledge of the information contained in this section. However, frequently small business owners have never had the benefit of formal business management training. In that event, this material should be helpful in better understanding the reports prepared by your accountant. Moreover, it will be useful in monitoring business performance and making sound business decisions on a daily basis. Financial Management © 8
  15. 15. Business reports Your business needs a specially designed accounting system. However, there is essential reporting that every business must have to effectively plan and direct the business. These key reports are the: Balance sheet Income statement Cash flow statement Additionally, the business needs to perform regularly a: Deviation analysis Break-even point (BEP) analysis A review of capital expenditure estimates Correctly used, these reports and analyses act as budgeting tools, an early warning system, a problem identifier, and a solution indicator. Use regularly and consistently because they are the backbone of the business. Several hours every month must be spent checking and analyzing these reports. The reports need not be very complicated and the level of detail will vary with every business. They are a reflection of your business and they are working models of your business. The more you work with these reports on a monthly basis, the greater your understanding and insight will be as to what your business needs to be healthy and profitable. A discussion of the some of these reports will follow. Making business decisions based on poor, incomplete, or superficial information can be disastrous. A business manager has two prime objectives and they are: 1. To make a profit 2. To pay the bills as they become due Financial Management © 9
  16. 16. The two key financial statements that convey this information are 1. The income statement (also called the profit & loss statement or the operating statement) 2. The cash flow statement Capital equipment list In addition to the above statements, every business should have a capital equipment list. A capital equipment list is a listing of the physical assets of the company. Examples of capital equipment are: Office furniture and equipment Manufacturing machinery Store fixtures Company vehicles Maintaining a capital equipment list is important because it helps to: Maintain control over depreciable assets Ensure that the reserve for replacement of capital equipment is maintained Ensure that the reserve for replacement of capital equipment doesn't become a slush fund to cover all sorts of other expenses other than what it was created for Facilitate the budgeting process as it comes time to replace equipment None of these expected capital equipment items may wear out for at least several years. However, their cost is depreciable as their life is used up. Assume that every asset in a company has a useable life and replaced at some point in the future. An estimate is made of the expected life of the asset and a portion of the original value of the asset deducted each year. This deduction is called depreciation. The depreciated value of an asset is the value after deducting the depreciation and it shows on the balance sheet. The depreciation expense is the amount of depreciation deducted each year and shown on the income statement as a used up value. Financial Management © 10
  17. 17. The capital equipment list can be very simple and should include columns to record the following information: The date of purchase Item description Model numbers Cost price including sales taxes and installation fees As well, columns should be included to record recovery and disposal costs in the event that sold items either before or after it is fully depreciated or costs are incurred in disposing of it. For some types of equipment, such as vehicles, provide columns for detailing the maintenance and repair costs that are incurred over the life of the asset. Many computer software accounting programs provide for managing the asset management information. Summary In Financial Data, we have provided an overview of the financial reporting needed to monitor the financial health of your business. We have discussed the relative importance of some of the reports and the need for keeping good records for capital assets. As well, we have stressed the importance of seeking the advice of your accountant in the financial management of your business. The main purpose of this financial data is to set the stage for the following sections: 1. Financial analysis of operations 2. Operational financial management 3. Monitoring the financial health of the business 4. Consideration in financing, business planning, and risk management Below are two sample forms: 1. Capital Equipment Record 2. Capital Expenditure Request Financial Management © 11
  18. 18. Capital Equipment Record Asset Group: Equipment #: ___ Record Date: ____ Location: Dept: Req #: PO#: ____ Item Description: Make: ____________________ Model#__________________ Serial#_________________ Purchase Date: _______ Supplier: Phone: __ Address: Fax: ______________ E-Mail: ______________________________________ Contact: Title: __ Purchase detail: Company: ________________________ Purchase price ______________ Address: _________________________ GST _______________ Phone: ___________________________ PST ______________ Fax: _____________________________ Total Cost ______________ E-mail: __________________________ Install service fees _____________ Contact: _________________________ Total installed cost __________ Title: ____________________________ Accumulate depreciation __________ Depreciated value ___________ % Depreciated ___________ Installer/Service Provider: Estimated Asset Life: Amortization Period: Financial Management © 12
  19. 19. Maintenance/Repair Record Date Maintenance/Repair Vendor Cost GST PST Total Description Totals Record additional maintenance and repairs on additional pages Asset Disposal and Expense Date of Disposal: __________________ Asset purchaser: Disposal/selling price: _________ Name: ____________________________ GST ________ Address: __________________________ PST _________ Phone: ____________________________ Total redeemed value _________ Fax: ______________________________ Less Disposal expense _________ E-mail: ___________________________ GST _________ Total Disposal expense _________ Net Asset cost recovery _________ Financial Management © 13
  20. 20. Capital Expenditure Request [Company Name] ACE.# Date: _____ Authority for: Capital expenditure Major repairs ______ Department name: Dept.# ______ Request authority for the following: Supplier name: ______ Description Estimated Cost Labour Materials Sub-total PST GST Final total Justification for expenditure: Safety Replacement equipment ___Necessary repairs ________ Cost saving Business expansion __________________________ Civic code requirements _____________________Other ___________________________ Payback period calculations: Initial cost: _______________________________________________________________ Annual savings [details attached]: _____________________________________________ Payback period [cost + savings]: ______________________________________________ Estimated date required: _______________Charge to: ____[Dept.]___________________ Requested by: _____________________________________________________________ [Title] Financial Management © 14
  21. 21. Approved by: ____________________________________________________________ [Title] Approved by: ____________________________________________________________ [Title] a. Attach written estimates whenever possible. b. Distribution: 1. To Controller for approval 2. To President for approval 3. To Accounting for coding c. Upon completion of the project, return to Accounting Manager. Date Completed: _________________Dept. Manager _____________________________ ------------------------------------------------------------------------------------------------------------ Financial Management © 15
  22. 22. This Capital Expenditure Request Form is included as an example of how to use a company internal document to justify the need to purchase an asset. It is a good idea for any business to use a form like this to: Think through the reason for the purchase What will be accomplished by making the purchase How long it will take to recover the cost of the purchase This form is part of the homework done by a manager prior to purchasing capital equipment. Estimates, product information, and attach anything else pertaining to the purchase to this form including in the Capital Equipment list file. In a small business, the owner or manager of the business would be using this form. In a larger business with several departments or divisions, the department or division manager would complete the form and submit it with all pertinent background information to senior management and the Controller. After the purchase is approved and completed, the details of the purchase are recorded on the capital equipment form. The Law of Money—of abundance There is an ample supply of money for all who want it. To get your share, decide to be rich, and obey the Laws of Cause and Effect as they apply to money. Financial Management © 16
  23. 23. Celebrate!! Financial Management © 17
  24. 24. B. Financial Analysis of Operations Introduction In Financial Analysis of Operations, we will discuss three basic components of operational financial analysis: 1. Job costing analysis preparation 2. Financial feasibility of business offerings 3. Break-even point (BEP) analysis In these segments, you will learn how to apply methodologies for internal analysis in any business. A brief outline of these segments follows: Financial Management © 18
  25. 25. (1) Job costing analysis preparation Job Costing Analysis Preparation presents in detail the steps any business would take to: Determine the fixed costs of the business Determine the variable costs of the business Ensure that the business recovers both fixed and variable costs in the pricing of its offerings Ensure that the business owner prices offerings at a level that will provide an adequate return on investment (ROI) after paying expenses Based on an actual architectural service business, this sample shows the steps taken in the analysis of fixed costs and the variable costs relating to projects. Translating the analysis of the price of the offering is included in several examples. (2) Financial feasibility of business offerings Financial Feasibility of Business Offerings discusses the factors that the business owner should consider in: Assessing the financial feasibility of new offerings Assessing the financial feasibility of existing offerings A few of the factors involved in assessing the financial feasibility of an offering are: Changing market conditions Customer and client analysis Changes occurring in the competitive environment How the offering relates to the offering mix What it will cost to effectively market the offering Changes that may be occurring to the ROI of the offering The examples in this material will enable you to relate the ideas to your business. It will help you to determine if you will make a profit marketing your offerings to your chosen market segments. Financial Management © 19
  26. 26. (3) Break-even point (BEP) analysis The material discusses break-even point (BEP) analysis and the uses of various ways to the monitoring of your business performance. A business manager will apply break-even analysis in one of its variations in many aspects of the business such as: Testing the financial feasibility of a new business opportunity Assessing the current financial viability of existing business segments Pricing merchandise at a level that will fully recover costs and generate a projected ROI There are several examples of several forms of break-even point (BEP) analysis and their possible use to your business. When you finished this section, think about the many ideas by asking yourself if: Your business would benefit from a detailed analysis of the fixed and variable costs You are now realizing full-cost recovery in the pricing of your offerings (product and services) You always analyze the financial feasibility of new ventures You frequently test the financial viability of operations using break- even point (BEP) analysis You are pricing for profit through the use of break-even point (BEP) analysis The Laws of Business—of innovation Breakthroughs come from innovation—offering something better, cheaper, faster, newer, or more efficient. All you need to break through is one good idea. Financial Management © 20
  27. 27. 1. Job Costing Analysis Preparation Introduction It is important for every business to determine accurately its fixed costs and variable costs. After that, the business must ensure that the revenue the business generates from the sale of its offerings counterbalances these costs. In Job Costing Analysis Preparation, we will first demonstrate how a business analyzes and determines the fixed and variable costs. Later in break-even point (BEP) analysis, we will discuss how the business uses information on fixed and variable costs to: Test the profitability of the business Project the viability and profitability of venturing into new markets Project the viability and profitability of new offerings Price offerings on a daily basis at levels that will ensure projected profits In Job Costing Analysis Preparation, we will explain how a company analyzes its fixed and variable costs and then ensures that the business recovers those costs and an adequate profit margin in the pricing of its offerings in every segment of business activity. For illustration purposes and simplicity, we will use a fee for service business. It is an architectural services company managed by the owner and five staff. As you move through this example, ask yourself how the ideas and methods presented here would apply to your business. Any type of business may use the ideas discussed. Every business situation will be different so be prepared to customize this process to meet your company's needs. Financial Management © 21
  28. 28. The job costing process The job costing process has six steps: 1. Research fixed costs 2. Determine revenue necessary to offset fixed costs 3. Calculating employee charge rate to recover costs 4. Segmenting services 5. Analyzing employee involvement and variable costs 6. Arriving at a price Step #1—Research fixed costs Begin by thoroughly researching the fixed costs of the business for at least the past two years. The purpose is to arrive at a base figure that accurately represents the total annual fixed costs. With some expenses, you may want to take an average of the cost over the two-year period. It is really for you to decide if periodic fluctuations in a cost warrant averaging the cost. You should adjust the base fixed-cost figure to reflect any estimated growth or decline in fixed costs to arrive at your estimated annual fixed costs. Fixed-cost items would include: Rent Mortgages Long-term loans Heat Light Telephone Building maintenance Administrative expenses There may be many other items depending on the situation of each business. Whatever the base or total fixed cost figure is, you should review it every year and make any necessary adjustments using the same simple methodology. Financial Management © 22
  29. 29. Step #2—Determine revenue necessary to offset fixed costs The second step is to express the total of the fixed costs in terms of how much money the office must generate to offset those fixed costs. If the office functions on a 40-hour week, that translates to 40 x 52 weeks or 2,080 hours of operation per year. Therefore, if you divide the estimated annual fixed costs by 2,080 hours, the result is the absolute minimum charge-out fee to recover those costs. For example: If the total fixed costs are $250,000, then the minimum hourly charge is $250,000/2,080 hours = $120.19/hour This is the absolute minimum amount of revenue that the business must generate to recover only the fixed costs. As well, it is useful to know what the charge-out rate would be if salaries and benefits are removed from the formula. For example: Estimated total fixed costs—(salaries + benefits)/total hours Assuming salaries + benefits are $150,000, the hourly rate would be: $250,000 – $150,000/2080 hrs = $48.08/hour These hourly charge figures represent how much the office must generate every hour that it is open to offset the operating costs. No allowance has been made for profit or ROI (Return on investment). Therefore, the actual hourly rate charged for projects must be substantially more. Financial Management © 23
  30. 30. Step #3—Calculating employee charge rate to recover costs Now, calculate the basic recovery charge-out rate for every employee in the operation including his or her portion of benefit costs. If the total benefits are 15% of the salary expense, here is what your analysis would look like: For example: Employee #1 $70,000/2,080 hrs = $33.65 + 15% = $38.70/hour Employee #2 $40,000/2,080 hrs = $19.23 + 15% = $22.12/hour Employee #3 $35,000/2,080 hrs = $16.83 + 15% = $19.35/hour Employee #4 $35,000/2,080 hrs = $16.83 + 15% = $19.35/hour Employee #5 $30,000/2,080 hrs = $14.42 + 15% = $16.59/hour These figures represent how much the business must charge for each employee for every hour that the business is open. Therefore, the charge-out rate on projects must be substantially higher to allow for variable costs, profit, and ROI. The example assumes declining salary levels from the owner at $70,000 to the lowest employee at $30,000. Financial Management © 24
  31. 31. Step #4—Segmenting services Segment all service components provided by the business. In the case of this example, a company providing architectural services, the components might be: Design Municipal approval Construction documents Construction services Perform a two-year review of each of these service components for each business segment and break them down into each cost item. For example: Time each employee contributed directly in office preparation Time each employee contributed in meetings Production materials Site services time Travel costs Telephone attendance time Telephone expense Additional insurance costs The office time contributed for each employee is partially offset by salary expense but the other items are all variable costs that must be recovered through the hourly charge-out rate for the project. By analyzing the history, you can usually predict (quite accurately) the percentage of variable costs to each type of total project cost. For example: If a certain type of project: Takes an average of 100 hours to complete The variable costs average is about 25% of the total job cost The average revenue generated is $10,000 In this scenario, calculate the variable cost recovery factor as follows: $10,000 x .25/100 hours = $25.00/hour Financial Management © 25
  32. 32. Each year, review the project history so that any necessary adjustments are made to this factor. Step #5—Analyzing employee involvement and variable costs At this point, analyze how much of each employee's time is typically involved in each service component on each project. Extend and total the salary and benefit cost that it represents Now, you can calculate the typical percentage of revenue that it represents and the hourly rate recovery factor. For example: Total salaries + benefits/100 hours = salary/benefit hourly recovery factor For the sake of illustration, this might work out to be $55.00/hour Step #6—Arriving at a price To be able to arrive at a project charge out rate that will recover the fixed and variable costs you must look at the typical production of the company. For example: If the company is operating at or near capacity, has been completing 15– 18 projects a year, and the projected volume for the year is 20 projects, then take a middle-of-the-road approach and use 18 projects as your reference point. With reference to how many of each project type are involved, calculate the total number of hours for all projects. Multiply the total project hours x (salary/benefit recovery factor + variable cost recovery factor) If total project hours were 1,500 hours, then the calculation would look like this: 1,500 project hours x ($55.00/hour + $25.00/hour) = project expense recovery Therefore, the project expense recovery = 1,500 x $80.00 = $120,000 Financial Management © 26
  33. 33. How does this compare to the projected operating costs for the company that we estimated in step #2? Recover the total operating expenses by the work that is completed. Therefore, the project expense recovery factor must be increased so that based on the projected volume (total operating costs + gross profit) are achieved. In the beginning, we said that fixed costs were $250,000. To offset this, based on productivity, the project expense recovery rate (PERR) must be: $ 80 = PERR $120,000 $250,000 Therefore: PERR = $80 x $250,000 = $166.67/hour $120,000 This factor is grossed upward to generate the gross profit margin you wish to achieve by dividing it by the difference between 100% and the % gross profit goal. If you wish to achieve a gross profit of 15%, you would divide the PERR rate by 1.00 –.15 = .85 to arrive at the project hourly charge-out rate (PHCOR). The calculation is: PHCOR = PERR = $166.67 = $196.08/hour .85 .85 Now, if you apply this rate to your projected 1,500 hours of project time, the result is $294,120. All of your expenses are covered and also you have allowed for generating a gross profit of $44,115. Of course, your analysis for your business will result in quite different figures but the methodology is the same. Completed this analysis periodically throughout the year ensures that the cost recovery and project goals are achieved. Financial Management © 27
  34. 34. Summary In Job Costing Analysis Preparation, we have demonstrated how to calculate a job costing analysis for a business. The process illustrated here is the same for any business. We used a fee-for-service business as an example because it made it easier to demonstrate the ideas involved. However, in a business that sells products derive the revenue from the sale of products. In that situation, consider only the net revenue or gross profit derived from the sale of the products when computing the calculations. Knowing the fixed and variable costs of the business is a key factor in performing break-even point (BEP) analysis (discussed later). In Monthly Performance Review and Analysis, we will look at how a business would use the job cost analysis and break-even point (BEP) analysis to measure the current performance of the business. The Laws of Money—of exchange Money is the medium for exchanging goods and services. It replaces barter. What you earn in an open market shows the value others place on what you Financial Management © 28
  35. 35. Celebrate! Anyone for a little surfing? Financial Management © 29
  36. 36. 2. Financial Feasibility Study of the Business's Offerings Introduction Whether it is a new business or an existing business, the decision-making process regarding what offerings your business is going to market, or is marketing, are the same. Note: We are using the term offerings to indicate either products or services. We have assumed that you have already completed: Competition and your competitive edge Market analysis A customer/client profile analysis Products and sources of supply The marketing plan The target market and target marketing plan For detailed information about any of the above topics, see The Business Plan A financial feasibility study will determine if your offering mix or offering line is financially doable. It answers this question: Will you make a profit with this offering line or offering mix to these designated market segments? Financial Management © 30
  37. 37. How to use this information Assume that you have already made tentative decisions about what offerings the business will sell. Take the last step to complete a financial feasibility study of the offerings before coming to a final decision about what offerings will sell. This feasibility analysis will determine if you can make a profit using this market segment with these offerings. For a new business, project the offerings and the calculation estimates based on industry norms derived from your market research. An existing business has the advantage of having historical data. Furthermore, it has a great deal of local knowledge about the market it serves. However, every time a business plan is prepared, it is important to go through the same process. It is important to: Test the current offerings mix Examine and consider new offerings that may be available or offered by competitors Through the financial feasibility process outlined below, your business will decide at regular intervals (yearly business plan process) whether to: Add new offerings Expand, curtail or eliminate current offerings This analysis is an important forerunner to the development of goals and results (objectives) and especially to the marketing strategy of the business plan. The reason is to direct the major commitment of the resources of a company towards the marketing of whatever offering mix is selected. Financial Management © 31
  38. 38. The analyzing process Use this analyzing process to determine if it is financially doable to sell the offerings To the various specified market segments At the specified prices The six steps of this analyzing process are: 1. List and describe the various offerings of your business (either the ones that you already have on hand or those that you tentatively have chosen.) There is an example below that demonstrates the next three steps. (2, 3, and 4) 2. Describe the relationship, if any, between each market segment of your business Describe the part each market segment plays in the business Identify the relative importance of each market segment of your business 3. State the volume contribution of each market segment versus the time spent and expenses incurred 4. State the profit contribution of each market segment versus the time spent and expenses incurred 5. Show a break-even point (BEP) analysis of each market segment (See Break-even Point Analysis) 6. Draw conclusions about your offering mix and your market segments No two businesses are the same. In addition, the relationship between business segments is often constantly changing. Here is an example of three of the steps (2, 3, & 4) mentioned above and how decisions can be made because of the analysis. The chart below provides the answers to the first five questions listed above: Financial Management © 32
  39. 39. The five market segments in this example are retail, commercial, industrial, government and institutional. The volume's contribution of each market segment is 25%, 45%, 15%, 5%, 10% respectively What proportion of revenue does each market segment contribute to the business? (See number 1 in the chart below.) What is the profit contribution of each market segment? (See number 2 in the chart below.) What is the proportion of the expenses used by each market segment? (See number 3 in the chart below.) Institutional Commercial Industrial Retail Gov't 1. Proportions of 25% 45% 15% 5% 10% revenue 2. Profits 55% 30% 3% 5% 7% contributed 3. Expenses used 30% 45% 10% 10% 5% You, or your business manager, may well decide that the sales volume and profit contribution of the industrial, government, or institutional business is not worth the drain on the resources of the organization. Because of the analysis, decide if it could cut back or eliminate these market segments. In this example, the commercial business segment uses 45% of the expenses and only contributes 30% of the profit. However, in this type of business often volume buying required to service the commercial business segment lowers the overall cost of the offerings. The commercial business segment enhances the profit margin of the retail market segment. If the company reduces the commercial business, it could have an adverse effect on the total profit of the company. Therefore, the decision will likely be to retain the commercial market segment. Financial Management © 33
  40. 40. As you can see from this simple example, the relationship between market segments can be complex and have many variable factors to consider. It is, therefore, very important that these relationships be analyzed frequently. You have completed the market research—now you can make some final decisions about the specific offerings with which you will provide your customers. Make those decisions. Complete this analysis more frequently than once a year. Add these other analyses to your business plan as addenda. It should include all the details that are pertinent to the offerings like the: Exact quality of offerings Name brands Volume Sizes Names of wholesalers Size of inventory If you are an existing business, indicate the ones added, modified, or changed from the last business plan. (Use colour for this step.) Uses of the analysis There are several uses for the offering analysis. Use it to: 1. Assist you in developing goals and outcomes for your business plan 2. Make decisions about retaining or dismissing either market segments or specific offerings 3. Make decisions about adding or modifying offerings or market segments 4. Make decisions of which market segments and offerings your new business will have 5. Write your marketing plan Financial Management © 34
  41. 41. Summary In Financial Feasibility Study of the Business' Offering, we had discussed the process of determining what the targeted market segments are and marketing which offerings. This provides you a framework for making decisions about the offerings your business would market. The process discussed here is one that all businesses should do at least once a year. As well, if you are contemplating: A change of direction for the company An expansion to new facilities or new markets An addition of a major product line The Laws of Money—of capital Your most valuable asset is your earning ability. It's physical, it’s mental—it's your capital. And, your most precious resource is your time. Financial Management © 35
  42. 42. Celebrate!! Financial Management © 36
  43. 43. 3. Break-even Point (BEP) Analysis Introduction to break-even point (BEP) analysis The break-even point (BEP) analysis is one of the most important tools in assessing the viability of pursuing new market segments as well as the relative return on investment (ROI) of various existing market segments. A break-even point (BEP) is the point where the business' total costs will just equal its total revenue. If you know the break-even point (BEP), you have a definite target to shoot for and can put a step-by-step strategic plan together to achieve the goal. For example Legend Red bracket indicates the loss area Orange bracket indicates profit area Pink bracket indicates total variable costs Yellow oval indicates the break-even point (BEP) Green bracket and line indicates total fixed costs Financial Management © 37
  44. 44. A break-even point (BEP) analysis can evaluate possible prices. Express the objective in dollars or units of product. A business should do a break-even point (BEP) analysis frequently. Then, it can be constantly aware of what has to be achieved before the business begins to make a profit. Certainly, before embarking on new programs or focusing on new markets, take in account all the expected costs and complete a break-even point (BEP) analysis. Sometimes, what looks like an attractive business opportunity is not so great upon closer examination. Increased sales do not necessarily mean increased profits. This is because a dramatic increase in sales, or the launch of a new program, may necessitate the purchase of additional equipment or the funding of additional internal or external resources. The result could be that the bottom line or net profit to the company will stay much the same. In other words, the return on investment (ROI) is not worth the additional expense. Sometimes, this is only a short-term effect and, in the long run, making the investment may be a good decision. Every business case is different and only the business owners or managers can make that decision. What often happens is the additional investment creates unused capacity in the business; thus, the significant increase amount of business required to break-even or reach profit goals. The break-even point (BEP) analysis helps the business owner or manager to make intelligent decisions when considering new programs or any additional investment in the company. Financial Management © 38
  45. 45. How to use this information Some of the figures you need to calculate the break-even point (BEP) will have to be estimates. It is often a good idea to use very conservative sales figures and overstate the expenses somewhat. Performing a break-even analysis Calculating the break-even point (BEP) can be simple for a single offering business, but more complex for multi-line or multi-service businesses. Whatever the complexity, the basic technique is the same. The basic break-even point (BEP) formula Formulae Meaning of the formulae Example S = FC + VC S = Break-even level of sales in dollars $221 = $55 + $166 FC = Fixed costs in dollars FC = $55 VC = Variable costs in dollars VC = $166 Examples of fixed costs are Rent Property tax and insurance Management salaries Interest on loans Office and administrative expenses Depreciation Examples of variable costs are Raw material Advertising and promotion Labour (wages) and payroll taxes Expenses for parts Packaging materials Utilities Outgoing freight Equipment maintenance Sales commission Miscellaneous expenses (office supplies, Contract people garbage removal) Note that both fixed and variable costs are part of operating expenses and they appear on the monthly operating statement (sometimes referred to as the profit and loss statement). A business selling offerings buys and sells inventory. Inventory is not part of operating expense. It is part of cost of goods sold (CGS). The examples that follow show the application of a gross margin (GM) to the sales price in order to determine break-even point (BEP) s and profit goals. Financial Management © 39
  46. 46. The methodology is valid in either a fee-for-service business with no inventory or a business selling offerings. However, in businesses with inventory, there are other issues related to accounting for inventory, inventory management, and offering turnover that will not be dealt with in this section. Assignment of Costs Complete the assignment of costs as detailed or generally as necessary. However, always complete it on the basis of percent (%) of sales (revenue). If property tax and insurance were $40,000 And the total sales revenue were $600,000 Then, property tax & insurance represents $40,000/$600,000 = .066 or 6.6% of sales In a business, that has several divisions or aspects to the business, (such as offering sales, a service department, and product installations) properly assign a fair share of the common overhead expenses. This assignment or pro-rating of common expenses is accomplished on the basis of the sales contribution of the different divisions. For example If the offering sales account is 45% of the total revenue The service department is 30% of total revenue And the product installations is 25% of total revenue Then, divide the office and administrative expense of the company in the same proportions between those divisions. Financial Management © 40
  47. 47. Take the same approach within a department in order to assign costs to a particular major offering group or a special project. Examples of variable costs 1. In a manufacturing business where acquiring raw materials is necessary, these commodities probably fluctuate in price. Labour costs may vary, and sales commissions or shipping costs may change. 2. In retail or wholesale businesses, the cost of goods sold (CGS) could increase or a new labour agreement with warehouse staff would increase labour costs. If the public carrier you use has to increase their rates suddenly, it will obviously increase shipping costs and affect the profitability of the business. 3. In a service business, starting a new project or service may require a greater amount of the business' resources than expected. Without careful analysis of the internal and external costs that would be involved, the business could be in for a nasty surprise. Some typical factors to examine are: The extra people necessary The additional resources devoted to servicing the client in the office The additional resources devoted to servicing the client in the field The additional marketing costs to launch a new program The possible increased liability exposure to the company The possible current and future costs imposed by regulatory agencies To what extent will the new program impact the financial resources and people resources of the company and, for what period? Without developing careful estimates of the expected costs and applying a break-even point (BEP) analysis test, the business could embark on a new program that could prove to be disastrous for the business. When doing these tests, develop at least three projections: An optimistic result projection An average result projection A pessimistic result projection Financial Management © 41
  48. 48. Variation of the break-even point (BEP) analysis Considering all the variable costs can require detailed analysis and very thoughtful consideration. This is necessary if you really want to know the true profit picture of the business. If you are calculating a projected break-even point (BEP), you may not know all of the variable costs, that being so, you may want to estimate various scenarios. In other words, prepare an optimistic, an average, and a pessimistic scenario. To perform these, a variation of the break-even formula may be used. There are at least three variations of the break-even point (BEP) analysis. Open up the Break-even analysis in Microsoft Excel on your CD and work through the interactive sheets with these variations. (1) When the gross margin (GM) is known Formulae Definitions of the elements of Example the formula S = FC+VC/GM S = break-even level of sales in S = $2,579.55 dollars FC+VC = fixed and variable FC+VC = $227.00 costs in dollars GM = gross margin as a % of GM = 8.8% (.088) sales In the above example $2,579.55 (S) = $227 (FC+VC) divided by .088 (GM) Alternatively, stated in another way: .088 (GM) times $2,579.55 (S) = $227 (FC + VC) Therefore, if you know what gross margin (GM) you normally expect to generate, you can test to see whether you recovered your basic costs. You may get this information from previous years' financial statements. You may also obtain it by consulting industry standards for your type of business. Financial Management © 42
  49. 49. Then, based on this historical information and actual percentage to sales relationships of expense items, you can estimate how much gross margin (GM) those expenses will likely consume. Equipped with this information, you can now make any necessary adjustments to gross margins or expenses to ensure the profitability of the business. In the example above, we illustrated: .088 (the GM) x $2,579.55 (Sales) = $227.00 (the sum of the FC+VC) If you are selling products, you may translate the dollar break-even point (BEP) into units of product by simply dividing by the unit cost of the product. (See the two examples below) To arrive at sales objectives for your sales people, you now are able to calculate how many units they must sell before the company starts to make a profit For some businesses, you may want to extend the exercise to show how many customers are needed to be profitable. See the example that follows. Here are two examples of using the break-even point (BEP) analysis formula: Example 1 Money needed per year/month for a break-even point (BEP) FC + VC = fixed costs + variable costs $14,700 per year GM = gross margin 20.7% BEP = FC + VC/GM (per year) $14,700/.207 = $71,014.50 (per year) (BEP means break-even point (BEP) *BEP per mo. = BEP per year/12 $71,014.50/12 = $5,917.87 (per month) Financial Management © 43
  50. 50. Example 2 You need the number of customers per day for a break-even point (BEP). There may be hundreds of items, all at different prices. This example simply assumes, for illustration purposes, that the average per unit is $3.00 in order that you can determine an approximate number of sales necessary for BEP. If the average unit selling price is $3.00 The average customer purchases two times per week $6.00 There are 4.3 weeks/month therefore, the average customer $25.80 sales/month = 4.3 x $6.00 = BEP = FC/GM (per month) $5,917.87 Consequently, the customers needed for a break-even point (BEP) are: 7.6 $5,917.87/$25.80 = $230 x 12 month = $2,760 per year/365 days = customers per day We rounded off the above figures off for simplicity. In addition, the example is typical of a business that sells products rather than a fee-for-service business. In a fee-for-service business, the GM percentage would be much higher, perhaps 60% or more and the necessary sales would then drop significantly. For example $14,700 (expenses)/.60 (GM) = $24,500 (sales) Financial Management © 44
  51. 51. (2) Profit planning formula The break-even analysis can be adapted to profit planning by simply altering the formula slightly. The basic formula is P = S - (FC + VC) This formula shows that if you subtract the sum of the fixed costs and the variable costs from sales, the left over is the profit to the company. Of course, if S - (FC + VC) = 0, then P in this formula is actually the break- even point (BEP) because the sales are exactly offset by the fixed costs and the variable costs. In practice, use the profit-planning version of the formula when the GM is known or assumed to be at a certain level. There are several uses of the profit planning formulae: 1. To illustrate the process, refer to our previous Example #1 where we show how a GM of 20.7% of sales is necessary for the business to break-even. Most people would not be satisfied with only breaking even. (GM = gross margin) After all, they may have their life savings invested in the business and could probably get a better return on their money by making other investments or simply leaving the money in the bank and drawing interest on it. Financial Management © 45
  52. 52. 2. Let us assume that the owners of the business in Example #1 feel that they should earn a 10% return because that is comparable to what they could earn on their money elsewhere. So now, rather than the GM being 20.7% of the selling price to equal the expenses, the GM will have to be approximately 31.0% of the selling price in order to offset the expenses and provide a profit of approximately 10%. In other words: .31 of the selling price (S) = profit (P) + costs (FC + VC) Formula Example .31S = P + (FC + VC) .31 x $71,014 = P + $14,700 $22,014.49 = P + $14,700 P = $22,014.49 – $14,700 P = $7,314.49 (3) Pricing product to achieve profit margin goals Now that you have established the gross margin (GM) necessary to cover costs and achieved the desired profit, how can you easily use this information to properly price products? The following formula will illustrate this as it applies to the example above: S - .31S = C The selling price (S) – .31S = cost of S - .31S = C inventory (C) .69S = C .69 x $71,014.50 = C C = $49,000 What we have shown here is that: If the GM is 31%, the cost of inventory is $49,000/$71,014.50 = .69 or 69% of the selling price. Accordingly, divide the cost price of any inventory item by .69; we will know the appropriate selling price to yield the desired GM of 31%. The formula is S = C/.69 Financial Management © 46
  53. 53. The formula presented here is useful in maintaining selling prices at levels consistent with the levels of GM percentage yield desired. This approach is also consistent with the way the business operating statement shows the financial data. The profit-planning formula is a useful tool in determining what sales are required to achieve a desired profit goal. You can see how useful and important the break-even point (BEP) analysis and the related formula are to daily operations and to business planning. There are many ways to use this technique and we have only discussed a few here. For instance If you were thinking of making a significant capital investment in the business, you might apply the above formulas to: Project a worst-case business scenario Project a best-case business scenario Project a most probable case scenario for your future business After consultation with your accountant, and performing a break-even point (BEP) analysis, you may decide to lease that expensive piece of equipment rather than buy it. Be creative and use the break-even point (BEP) analysis in areas of the business other than sales. You often have more control over expenditures than you do over sales. A break-even point (BEP) analysis is helpful but do no follow it blindly. It is useful for analyzing costs and for evaluating alternatives. The prudent business owner or manager should also relate any analysis to a 'gut feeling' for the needs of the marketplace. Financial Management © 47
  54. 54. Points to consider when using break-even analysis and related formulae The break-even point (BEP) analysis does not consider the effect of price on the quantity that customers/clients will want (the demand curve). It evaluates whether the company will be able to break-even with a particular price, on a specific offering, at a particular point in time. It is usual to base the factors used in the formulae on historical data. The marketplace is unpredictable and conditions can, and do, change very rapidly. Thus, although break-even analysis and the related formulae are very useful tools, the business owner or manager must use them in relation to her/his best estimate of the changes in market conditions. Sudden increases in operational costs can impact profitability. Sudden increases in offering cost prices can necessitate big increases in pricing that may result in plummeting sales. Unexpected consumer demand may result in shortages of supply or the need to commit greater resources to customer service. In either event, the impact on profitability could be significant. Suddenly confronting the business with extremely strong price competition could drive prices down and affect profits. It is a good idea to get in the habit of testing and monitoring the performance of the business on, at least, a quarterly basis. Risk assessment and break-even analysis should be part of any business plan along with the development of contingency plans in case of the worst-case scenario occurring. Financial Management © 48
  55. 55. Uses of the break-even point (BEP) analysis The break-even point (BEP) analysis can to be used to: Evaluate possible prices of the various product lines Monitor the viability of existing business segments Assess the viability of pursuing new market segments Assess the relative return on investment (ROI) of various existing market segments Test the effect of changing market conditions on business segments Test the viability of any expansion plans such as adding new equipment or entering a new market Assess after adding additional production equipment Assess after increasing staff for any reason Assess if there are sudden increases in fees, licences, or taxes from government or regulatory agencies Assess after—increasing marketing costs to promote an offering. Assess after—increasing marketing costs to service a new market. Summary In this material, you have learned how important break-even point (BEP) analysis is as a business-monitoring tool. We have discussed variations of the break-even point analysis and examples of how to use them within the business. We have shown you how to use break-even analysis and its variations to: Test the feasibility of new business ventures and offering introductions Test the effect of changes in market conditions Price offerings at a profitable level The Laws of Money—of time perspective The most successful people make their day-to-day decisions by considering the longest time period. Delayed gratification is the key to financial success. Financial Management © 49
  56. 56. Celebrate!! Financial Management © 50
  57. 57. C. Operational Financial Management Introduction In Operational Financial Management, the focus will be on the following three topics: 1. Inventory management 2. Accounts receivable and credit policy 3. Preparing pro-forma cash flow statements Operational Financial Management is particularly concerned with managing the flow of cash in and out of the business. It is also concerned with how to utilize the cash by the business to provide the best return on investment (ROI). As you move through this section, think of how you presently manage your business in relation to these three subject segments. A brief outline of these segments follows: Financial Management © 51
  58. 58. 1. Inventory management In Inventory Management, you will learn the different ways in which inventory is evaluated. Samples will provide you with examples that will help you in properly evaluating the inventory in your business. Managing the product mix in a business can be a complex issue. Inventory Management will present ideas on how to manage the product mix to obtain the best return. As well, you will learn the importance of maximizing inventory turnover. You will see ideas and examples that you can apply to your business. 2. Accounts receivable and credit policy In this segment, you will learn the importance of designing a credit policy that will best serve the needs of the business and market it serves. You will learn that creative use of credit policy can be an important part of both: The sales and marketing management of a company The financial management of a company We will discuss the effect on the business of effective credit policy and management. You will learn about the typical accounts receivable (A/R) reporting tools and their use. You will also learn methods of managing credit sales and the resulting accounts receivable (A/R). Financial Management © 52
  59. 59. 3. Preparing pro-forma cash flow statements In Preparing Pro-forma Cash Flow Statements, we will present in detail the elements of a cash flow statement and its preparation. You will learn, step by step, how to prepare a cash flow statement and will be able to apply this directly to your business. We will discuss the importance of using the pro-forma cash flow statement to: Forecast the expected revenue and expense for the fiscal year Plan for potential shortfalls in business revenue Communicate financing needs to a lender At the end of this material, we provide sample spreadsheets to assist you in preparing a cash flow statement for your business. When you have finished, think carefully about the ideas presented. Consider how you operate now and what ideas would improve your business now or in the future. The Laws of Business—of obsolescence Whatever is, is already becoming obsolete. Change prevails—–it's unavoidable. A successful business adapts quickly; even better, it helps create change. Financial Management © 53
  60. 60. 1. Inventory Management Introduction For any company that handles inventory, the inventory represents a major investment for the company. For many companies, the value of the inventory is the value of the company. It may be the largest asset of the company. Therefore, inventory deserves careful attention and proper management in order for it to yield the maximum return on investment (ROI) to the company. The purpose of Inventory Management is to generate more awareness of common approaches to managing inventory. We will discuss some inventory management ideas in income statement analysis in relation to the cost of goods sold (CGS)—ideas such as inventory turnover and the evaluation of inventory. Now, we will build on those ideas and discuss other ideas related to good inventory management. We will focus on four important areas: 1. Inventory evaluation 2. Managing the product mix in inventory 3. Inventory investment 4. Inventory turnover How to use this information As you read this material, you should think about: How you presently manage the inventory in your business What you presently do to manage the amount of money invested in each product category What do you now do to manage and control the quality of your inventory What do you do now to promote inventory turnover Financial Management © 54
  61. 61. a. Inventory evaluation Evaluation of the inventory can vary with the industry and the type of business. Natural resources, manufacturing, distribution, and retail—all of these industries may evaluate inventory differently. Within these industries, evaluate some groups of products differently because of the nature of the product and the handling of it. If your industry or business has special inventory evaluation concerns, you should consult your accountant for direction. For the purpose of discussion in this segment, we will only be concerned with presenting the main approaches to inventory evaluation. There are three methods of inventory evaluation: a. First in first out (FIFO) b. Last in first out (LIFO) c. Weighted average From an accounting point of view, it usually doesn't matter the choice of method as long as its use is consistent. However, each method can affect cost of goods sold (CGS) differently. In addition, the rate of inventory turnover and tax considerations may influence the choice of method. For the purpose of illustration of these three methods, in the next three segments we will use the following example: Acme Mercantile inventory records show the following information. Beginning Inventory Units 1000 @ $1.00 ea. = $1,000 Purchase #1 Units 2000 @ $1.12 ea. = $2,240 Purchase #2 Units 2000 @ $1.22 ea = $2,440 Total Units 5000 Total value $5,680 Ending Inventory Units 2000 Units Sold 3000 This example indicates only two purchases; however, in practice, there may be many purchases. Financial Management © 55
  62. 62. (1) First In first out (FIFO) The FIFO method of inventory evaluation assumes that: The first items (purchase for inventory) are the first items sold. Therefore, using the assumed figures for Acme Mercantile, the following scenario illustrates how the FIFO method works. If 3000 units are sold: Units Sold 1st Units sold 1000 @ $1.00 ea.= $1,000 nd 2 units sold 2000 @ $1.12 ea. = $2,240 Cost of Units sold $3,240 Cost of units remaining in inventory $2,000 x $1.22 ea.= $2,440 (2) Last in first out (LIFO) The LIFO method of inventory evaluation assumes that: The last items purchased for inventory are the first items sold. Therefore, using the assumed figures for Acme Mercantile, the following scenario illustrates how the LIFO method works. If 3000 units are sold: 1st units sold 2,000 @ $1.22 ea. = $2,440 nd 2 units sold 1,000 @ $1.12 ea. = $1,120 Cost of units sold $3,560 ----------------------------------------------------------------------------------------- Cost of units remaining in inventory 1,000 x $1.22 ea = $1,220 1,000 x $1.00 ea = $1,000 Total cost of remaining units in inventory = $2,220 Financial Management © 56
  63. 63. (3) Weighted average The weighted average method of inventory evaluation assumes that: Unit cost of inventory is the total cost of inventory divided by the number of units. Therefore, using the assumed figures for Acme Mercantile, the following scenario illustrates how the weighted average method works. If 3000 units are sold: Weighted average cost is $5,680/5,000 units = $1.136/unit Therefore, cost of units sold is 3,000 x $1.136 = $3,408 Total cost of units remaining in inventory is 2,000 x $1.136 = $2,272 In the three methods of inventory evaluation, you can see that: The cost of units sold is different The cost of the units remaining in inventory is different The reason is that the evaluation assumption is different. None of the three methods are wrong, but the method chosen will affect the cost of goods sold (CGS) calculation and hence the profit calculation for the period. 1. The FIFO method is the most widely used. It produces values closer to current market values since it includes costs that are more current. You could say that this method encourages the turnover of inventory because the better the turnover rate, the closer the inventory valuation will be to current market costs. However, it still slightly underestimates current market value because it does include earlier costs. 2. The LIFO method generally results in undervalued inventory. If you use this method, you are not allowing for the replacement cost of your inventory. LIFO may not be acceptable by governments in some jurisdictions because, by undervaluing inventory, the CGS is overstated and this has the effect of lowering the taxable income of the company. 3. The weighted average method tends to produce values that are similar to FIFO because it blends the cost of all the items in inventory. However, this does depend on the type of business and the turnover rate. Financial Management © 57
  64. 64. (4) Periodic and perpetual inventories The inventory calculation examples (shown above) assume that on a periodic basis, the inventory is counted and evaluated. It is a legal requirement in most jurisdictions that at least once a year or in a 12-month period, there should be a complete physical inventory In practice today, many businesses use a perpetual inventory system where the cost of blending existing inventory constantly with the cost of new items acquired for inventory. Electronic inventory management systems and accounting software handles perpetual inventory systems with ease. Many such systems will allow inventory calculations using the different methods of evaluation. Sometimes, within a particular business, evaluating product categories differently can present a more accurate picture for tax purposes. Financial Management © 58
  65. 65. Managing the product mix in inventory The product mix is a term that refers to the product selection that a company stocks and the amount of those products that are stocked. The product mix in the inventory of a company is very important. If you don't have the right amount of each product at the right time, it can have a significant effect on the profitability of the company. Managing the product mix involves: Selecting main product lines that will complement each other in terms of quality range and price range Selecting the right accessory and related products to go with the main products Accurately projecting the required stock quantities at all times and determining the amount of additional stock required in peak or seasonal periods. Establishing minimum and maximum inventory levels for all items for each period of the fiscal year Accurately determining the inventory value of each part of the product mix Ensuring that units of product in all segments of the product mix are in saleable condition Promoting the turnover of inventory to ensure that the majority of product units are fresh and as recently purchased as possible Consciously and aggressively moving overage, damaged or poor quality inventory Financial Management © 59
  66. 66. b. Inventory investment Being constantly aware of the amount of money necessary to maintain established inventory levels is a key factor in managing inventory. Without awareness and exercising spending control, a business could easily spend profits or even the proceeds from gross sales on items other than inventory. In this event, the problems resulting could be: Lack of funds to reinvest in inventory Borrow money to reinvest in inventory. This increases expense and, therefore, can lower profits Less inventory to sell of important product lines and, therefore, lower sales Inability of the business to react to customer demand for new products Loss of customer confidence in the business as a supplier Loss of market share These points illustrate how important it is to maintain inventory levels at acceptable levels in all segments of the product mix. Maintaining inventory levels of key products is vital to the success of your business. To ensure that your business maintains inventory at required levels, you should prepare detailed inventory reports. The frequency of preparing the reports may vary with some businesses. Businesses with higher turnover rates need to prepare the reports monthly, but many businesses would likely find that quarterly inventory reports are sufficient. These reports should show the inventory value of each item in inventory as well as the total value for the product segment of which it is a part. The report should show comparative figures to the previous period so identify changes in value. These reports will be labour intensive to produce by hand, but many accounting software programs or business managerial software programs will easily produce detailed inventory reports at the push-of-a-button. Consult your certified accountant on the accounting needs for your business. Financial Management © 60
  67. 67. Based on the inventory reports, you need to budget money for monthly maintenance of the inventory investment in each product. A portion of this money really represents a portion of the cost of goods sold (CGS). To maintain inventory investment, replace the CGS each month. Therefore, allocate that portion of your sales revenue represented by the CGS each month to replace the inventory investment. It is a good idea to compare the % to sales of CGS from one period to another on the income statement. In Income Statement Analysis, we will discuss the inventory section of the income statement. Revisit or visit that section and review the discussion about inventory, CGS, and the statement of inventory value. c. Inventory turnover The question of monitoring and controlling inventory turnover has come up a number of times in our discussions about inventory management. Inventory turnover affects all the items we have discussed so far—evaluation, product mix, and investment. In reference to the examples above, we have referred to inventory turnover effecting the calculations and they will widely differ. You will find little difference in the calculation methods in businesses with: Higher turnover rates and low inventory values You will find bigger differences in the calculation methods in businesses with: Lower turnover rates and higher inventory values In either case, it is evident that inventory turnover rates are a key factor in business profitability. To facilitate inventory turnover, every business should: a. Use inventory identification methods—Inventory identification b. Assign a length of time an item may be in inventory—Length of time in inventory c. Produce inventory movement reports each month—Inventory d. Produce monthly overage inventory reports—Overage inventory report We will now discuss these four items: Financial Management © 61
  68. 68. (1) Inventory identification Identify every item in inventory needs as to: An inventory ID number When the item was brought into inventory The cost price of the item In addition to the product ID number, use a product code of some sort to mark the purchasing information on a tag attached to the item or use a stamp to stamp it on the package. For example: Product codes may be alpha numeric and the variety of systems is unlimited. A typical example of using a code in a retail store is as follows. Assign a number to each month of the year—#1 for Jan. #2 for Feb.— until each month of the year has a number. Choose a word with 10 letters or perhaps two words that total 10 letters and assign each letter a number in sequence from 1–9 + a letter for 0 as follows: B LA C K H O R S E 1 2 3 4 5 6 7 8 9 0 Purchasing an item of inventory at a purchase price of $24.90 the store would code the information as follows: #2–LCSE–99 Many stores use this simple method so that without the aid of electronic scanners a clerk in the store can see at a glance how long the product has been on the shelf and the cost price. The clerk would use this information to: Sell first the items that have been in inventory the longest. Even if several items on a shelf are identical, it is important to have the most fresh, recently purchased inventory on hand. To make on-the-spot price adjustments, if necessary, while still maintaining a minimum GM. Knowing exactly how much profit there is in an item is an advantage when dealing with a customer. Financial Management © 62
  69. 69. Clerks using a product code like this become very proficient at reading the code without any hesitation. It becomes second nature to them as they are working with it all the time. Usually incorporated into the barcode is exactly the same kind of information you see on price tags in stores and on most packaging today A barcode is a strip of lines of various widths that represent all the product and pricing information for that inventory item. When the barcode is scanned (with a barcode scanner at the point of sale (POS) or read by a clerk), all of the product and price information on the code is retrieved. Here is an example of a barcode: Example: Another device that is useful in identifying Inventory at the point of sale (POS) is colour coding. Colour codes can help a sales clerk to identify the oldest inventory and its purchase date. For example: Tracking the age of inventory in the retail clothing business can make a big difference in inventory turnover and the salability of inventory. Clothing inventory becomes obsolete very quickly because of: Seasonal demand Changing styles in fashion If clothing stores did not promote high turnover of inventory, the overage inventory would soon choke it. This is why you frequently see inventory-on- sale at clothing stores. Financial Management © 63
  70. 70. Producing inventory movement reports at the push of a button on your computer works well in getting a global picture of the inventory in the store. However, at the POS, a clerk serving a customer in front of a rack of similar jackets will benefit from a quick visual method of determining the age of inventory. A simply device that is used by some retailers is to colour code the tags on the inventory. Coloured price tags are readily available from store fixture and supply wholesalers. Assign each month of the year a colour. You might decide upon: Red January Green February Light yellow March Blue April A clerk looking at a rack filled with similar jackets would know at a glance that the jacket with a light yellow tag had been in inventory the longest. The clerk would then try to promote the sale of those items. There are many ways to identify inventory. The system used will depend on the type of business and the inventory stocked. Be creative in your business. You should think of ways that you can do a better job of identifying your inventory in order to promote turnover. (2) Length of time in Inventory Assign each product group in inventory a maximum time in inventory. Assign a shorter or longer time for some items within a product group. Even items that you think are very durable or won't become obsolete in a short time should be assigned a maximum time that you will keep them in stock. Sitting on a shelf or hanging on a rack inventory will: Become ingrained with a certain amount of dust Become soiled from handling by customers Acquire nicks or chips from jostling against other products Not look fresh and new to customers It is important to maintain inventory in as good condition and appearance as possible as well as to promote inventory turnover. Financial Management © 64
  71. 71. Once you have assigned a time limit to the inventory, use a visual method similar to that previous discussed to identify it. In assigning a time limit to products, consider the following points: Look at inventory movement standards for the product in your industry Consider that it is your money that is invested in and tied up in the product as long as it sits in inventory Consider how perishable the product is. Will it deteriorate in value over a short time such as vegetables? Consider the seasonality of the product. That means to consider if it is an item that mainly sells in spring, summer, and fall or winter season How soon will the product become obsolete? Is it likely to become out of fashion in 3–6 months? Many industries consider that if a product has not sold for a year, the business has lost at least 30% of the value of the product by not turning over the money invested and reinvesting the money in new products. For example: A hardware store has hammers that were purchased for $15.00 and sell at a 33⅓% GM at $22.50 each. If these hammers do not sell for a year, the store has: Not made the expected GP of $7.50 each on these hammers Not been able to apply this GP against operating expense Not been able to reinvest the store’s own money in other products Although a hammer would not be considered a perishable item or subject to changes in fashion, the store must turn the money invested in inventory in a timely fashion in order to be profitable. Financial Management © 65

×