Cadden_PPT_Ch10 update-1.ppt

Small Business Management in
the 21st Century
David T. Cadden and Sandra L. Lueder
1
© 2012, published by Flat World Knowledge

COPYRIGHT PAGE
Published by:
Flat World Knowledge, Inc.
One Bridge Street
Irvington, NY 10533
© 2012 by Flat World Knowledge, Inc. All rights reserved. Your use of this work is subject to the
License Agreement available here http://www.flatworldknowledge.com/legal. No part of this
work may be used, modified, or reproduced in any form or by any means except as expressly
permitted under the License Agreement.
2

Chapter 10
Financial Management
3

News & Books
• Importance of Financial Management
Very few careers can offer you the freedom, flexibility and income that day trading does. As a day trader, you can live and work
anywhere in the world. You can decide when to work and when not to work. You only answer to yourself. That is the life of the
successful day trader. Many people aspire to it, but very few succeed
1-4

Small Business
• A Day in the Life
1-6

Learning Objectives
1. Understand the difference between accounting and finance
for small business.
2. Understand the major activities of finance.
3. Understand how finance can affect the selection of a
business form.
4. Understand the various sources that can be used to finance
the startup operations of the business.
5. Understand what factors might affect the extent to which
the firm is financed by either debt or by equity.
7

Learning Objectives
6. Learn about the importance of cultivating a
relationship with your banker.
7. Understand the elements of CAMPARI approach to
evaluating a loan.
8

Learning Objectives
8. Learn the importance of a breakeven analysis.
9. Understand how to conduct a breakeven analysis.
10. Understand the potential power and danger of
financial leverage.
11. Learn how changing financial leverage can affect
measures of profitability such as ROA and ROE.
12. Learn how to use use scenarios to evaluate the
impact of various levels of financial leverage.
9

Learning Objectives
13. Understanding that the effective and efficient
financial management can enhance value provided
to customers.
14. Appreciate that effective financial management
can improve the firm’s cash flow position.
15. Understand that the use of technologies can
significantly reduce cost of operations and
improve profitability.
10

Class Participation
• Pair up with a partner, use your digital device (tablet,
cell phone, laptop)
– Finance … Have you thought of regarding your business?
– Take a look online how many ”self-help” ideas there are?
– What is 1 key that you think would help you?
1-11

Finance
• Basics 101 5:00
• Finance can be seen as "the science of money
management".
• It can be seen as consisting of three major
activities:
– Financial planning
– Financial control
– Financial decision-making
12

Finance
• Financial planning deals with the acquisition of adequate
funds in order to maintain the operations of the business and
to make sure that the funds are "available at the right time".
• Control seeks to assure that assets are being "utilized
efficiently" .
• Decision-making is associated with determining how to
acquire funds, where to acquire funds and how those funds
should be used and within the context of the risk assessment
of the aforementioned decisions.
• Financial Decisions 3:00
13

Finance and Organizational Type
• The federal government recognizes six forms of business
organizations for tax purposes:
– Sole Proprietorship
– Partnership
– Corporation
– S-corporation
– Trust
– Nonprofit
• What did Grace say her company was?
• The last two are unlikely to be used by a small business.
• Each of the remaining four formats have implications
for financial management and tax issues.
14

• Sole Proprietorship
– Many small businesses operated by a single individual adopt sole
proprietorship format of business organization.
– It is the most basic type of business organization.
– It is also the least expensive to create easiest to operate and to
dissolve.
– Sole proprietorships disappear upon the death of the owner.
– This type of business is taxed as personal income.
– The owner can extract all profits from the business for their personal
use or the owner can decide to reinvest any portion of the profits back
into the business.
– 70 percent of all businesses in the United States are sole
proprietorship's yet they only produce 20 percent of
all the nation’s profits.
15

• Partnerships
– Partnerships generally are unincorporated businesses.
– By having more than one owner (investor) it is often
easier to raise additional capital.
– General partnership is comparable to sole
proprietorship in that neither are a taxable entity;
therefore, the partners’ profits are taxed as personal
income.
16

• Limited Partnership is a business that may have
several general partners and several more limited
partners.
– The major difference with general partnership is that
the limited partners do not have unlimited liability.
– Their losses are limited to the original investment in
the business.
17

• C-corporation
– This form of business entails more effort and expense in
creating this format.
– Corporations must be chartered by the state in which it is
headquartered.
– Corporations are viewed as legal entities meaning they can
enter into legal agreements with individuals and other
corporations.
18

• C-corporation
– Corporations are owned by their shareholders.
• The shareholders are liable only for the original investment in the
business.
– It sometimes much easier to raise capital either through
debt or through the issuance of stock.
– Profits derived from this type of business are taxed at the
corporate rate.
19

• S-corporation
– This is a special format designed to eliminate the problem
of double taxation.
– It first differs from a C-corporation format in that it is
limited to 100 shareholders.
– If a shareholder is an employee of the business and
contributes any service to the business then the
Corporation is required to pay that individual a salary.
20

S/C Corporations
• Summary 5:00
© 2012, published by Flat World Knowledge 21

Class Participation
cell phone, laptop)
– In groups, talk about what business corporation you will be
using C-Corp/S-Corp/LLC?
– What do you think are the strengths and weaknesses?
1-22

Acquisition of Funds
• Capital is the life’s blood of all businesses.
• It is needed to start a business, to operate a business
and to expand a business.
• Capital comes from several sources:
– Equity
– Debt
– Internally Generated Funds
– Trade Credits
23

Sources of Capital
24

Sources of Equity:
Equity Financing
• Equity financing raises money by selling a certain
share of the ownership of the business.
• A major source of equity financing for most small,
startup businesses comes from personal savings or
investments from family and friends.
– What do you think about this … friends/family?
• A corporation may issue stock.
• There are two major types of stock – common and
preferred stock.
25

Sources of Equity:
Equity Financing
• Another source of financing comes from venture
capitalist.
– They look for substantial returns on their initial investment
– 5, 10, sometimes even 25 times their original
investment.
– They look for firms that can rapidly generate significant
profits or significant growth in sales.
• Still another source comes from angel investors.
– They may be more attracted to their interest in the small
business concept that in reaping significant returns.
– It is much more likely that Angel investors will play a much
more active role in the decision-making process of the
small business then venture capitalists.
– Guy Story 3:00
26

Quick Statistics

Sources of Debt Financing
• The largest source of debt financing for small businesses in the United
States comes from commercial banks.
• These loans can either be secured or unsecured.
– Secured loans involve the pledging of some assets – such as a home,
real estate, machinery and plant as collateral.
– Unsecured loans provide no such collateral, and as such because they
are riskier for the bank they generally have higher interest rates.
– Money Coach 3:00
28

Capital Structure – Debt vs. Equity
• A critical component of financial planning for any
business is the determination of the extent to which
the firm will be financed by debt and by equity.
• This decision determines the financial leverage of
the business. Many factors enter into this decision
particularly for the small business.
29

Capital Structure – Debt vs. Equity
• Beyond a certain point the
debt may be out of reach and
therefore the entire "lifting"
power of financial leverage
may be lost.
• The assumption of too much
debt may lead to an inability
to pay the interest on the
debt.
• This situation becomes the
classic case of filing for
Chapter 11 bankruptcy.
• Chapter 11
30

Class Participation
cell phone, laptop)
– Do you have a relationship with the bank?
– If so, has it saved you?
– What will you do to establish a relationship?
– What does the future look like for banks?
1-31

Relationships with Bankers
• It should be the responsibility of the small business owner to maintain
frequent contact with whoever is representing the bank.
• This should involve more than just providing quarterly statements. It
should include face-to-face discussions and even asking them to tour the
facilities.
• The point is to personalize the working relationship between the two
parties.
32

CAMPARI
• It is said that bankers when reviewing a perspective
loan applicant think of the acronym “CAMPARI”.
• Banking Explained 6:00
• This actually term stands for:
– Character
– Ability
– Means
– Purpose
– Amount
– Repayment
– Insurance
33

CAMPARI
• Character
– Part of that definition of integrity will include a
sense of professionalism which can be reflected in
one's attitude and dress. Bankers will also review
one's history as a business leader. This notion of
character may also be extended to the upper
echelon of the management team of the small
business.

CAMPARI
• Ability
– The bank is concerned with repayment of the loan
and interest. The application of the loan should be
able to demonstrate clearly the business's ability
to repay the loan. Everything should be brought to
bear to prove that the loan will not be defaulted
upon and that it will be paid in a timely fashion.
35

CAMPARI
• Means
– This refers to the business's ability to be able to
function so that the loan will be repaid. To show
that your business plan should clearly indicate the
business's ability to repay the loan. It should also
be able to cover any issue that would convince the
banker of the validity of the overall plan.

CAMPARI
• Purpose
– Bankers want to know to what purpose the borrowed
money will be put. One should clearly identify where
the money is going, such as purchasing a piece of
capital equipment.
• Amount
– It is very important that you are able to specify the
exact amount of the loan and also to justify
how you determined this amount of money.
37

CAMPARI
• Repayment
– This refers to demonstrating your ability to repay
both the interest and principal. Again, detailed
documentation such as sales projections,
projections and profit margins and projected cash
flows are essential if you wish to secure the loan.
38

CAMPARI
• Insurance
– The best of plans may not pan out. One should
show contingencies plans to the bank that would
indicate how you would be able to repay the loan
in the event that the scenarios that you've
identified do not come to fruition.

Class Participation
cell phone, laptop)
– CAMPARI … your thoughts?
– Recession 2006 Bank Failure
– Will you go online (Bitcoin)?
1-40

Breakeven Analysis
• Breakeven analysis is a remarkably useful to
someone considering starting up a business.
• The purpose of a breakeven analysis is to determine
the sales volume that would be required so that you
neither lose money nor make a profit.
• This translates into a situation in which the profit
level is equal to zero.
– Easy Explanation
• Put in equation form this simply means:
Total Revenue - Total Costs = $0
41

Breakeven Analysis
• By moving terms, we can see that the breakeven
point occurs when Total Revenues = Total Costs.
• We can define Total Revenue as the selling price of
the product times the number of units sold. This can
be represented as follows:
Total Revenue (TR) = Selling Price (SP) * Sales Volume (Q)
or
TR = [SP * Q]
42

Breakeven Analysis
• As production rises the Total Variable Cost will likewise rise. This can
be represented as follows:
Total Variable Cost (TVC) = Variable Cost per unit (VC) * Sales
Quantity (Q)
or
TVC = [VC * Q]
• Total Costs (TC) is simply the summation of the fixed cost plus the
total variable cost:
Total Costs (TC) = [Fixed Cost (FC) + Total Variable Cost (TVC)]
or
TC = [FC + TVC]
43

Breakeven Analysis
• At the breakeven point Revenues equals Total
Costs, so the above equation can be rewritten
as:
Selling Price (SP) * Sales Volume (Q) =
[Fixed Cost (FC) + Total Variable Cost (TVC)]
or
(SP * Q) = [FC + TVC]
44

Breakeven Analysis
• This equation can be rewritten so as to solve for the value of
Q - the sales value:
[SP * Q] - [VC * Q] = FC
• The term Q (Sales Volume) is present in both terms on the left
hand side of the equation so it can be factored at producing:
Q * [SP – VC] = FC
• The sales value to produce the breakeven point can now be
solved for in the following equation:
Q = FC / [SP – VC]
45

Breakeven Analysis
• To illustrate, a stall at a local mall sells cell phone cases for
$15.00. the cost of each case is $7.50 per case. The monthly
rent charged by the mall is $1500 per month.
How many cases must this stall sell each month to breakeven?
SP = $15.00; FC = $1500.00; VC = $7.50
Q = FC / (SP – VC)
Q = $1500.00 / ($15.00 - $7.50)
Q = $1500.00 / ($7.50)
Q = 200 cases
46

Cash Flow Implications
• Two areas where good financial management can
help cash flow are:
– E–procurement
– Factoring
• E-procurement involves managing the timing of
invoices to customers and from suppliers so as to
improve the cash flow of the firms.
– The electronic handling of orders and their associated
invoices assures that customers will receive their orders in
a more timely fashion.
– E-procurement means that fewer personnel are
required to take and handle orders.
– E-Procurement 4:00 47

Cash Flow Implications
• Factoring is associated with the businesses accounts
receivable.
– Firms may offer discounts to customers who pay early;
however, they may also know that customers are unlikely
to take advantage of the early payment discount.
– Have you taken advantage of this discount?
48

Influence of Technology, E-commerce and E-business
• Firms can strengthen their financial position by moving
their software programs and databases to an outsourced
site. This is often referred to as cloud computing.
• Cloud Computing Explained
• Advantages of cloud computing include:
– Reduction in the number of computers, servers and
network connections that a small business firm requires.
– Scalability: Cloud applications can grow with the business.
Some charge on the basis of the
number of users.
49

• Advantages of cloud computing (continued)
– Updates: The latest version of software is done
automatically by the vendor.
– Access: Cloud programs can be accessed wherever
one is a connection to the Internet.
– Integration: Having programs and databases on
the cloud facilitates multiple members of the
organization to be able to successfully work
together.
50

• Advantages of cloud computing (continued)
– Security: Cloud providers recognize the securing their
clients data is a core issue for their survival. The
vendor has a much greater capability of assuring
security.
– Cloud Security 4:00
– Customization: Businesses can acquire the software
that they need.
– Extensions into the World of Social Media: Cloud
providers can assist businesses who wish to utilize
various forms of social media (Facebook, Twitter,
LinkedIn, etc.) yet lack the technological savvy
to do so.
51

Class Participation
cell phone, laptop)
– Cloud Computing … do you think it will impact you?
– Let’s hear a few statistics about it.
1-52

Follow-Up
• Module 10-
– Chapter 10 Test
• Due on Sunday
• Module 11-
– Assignment #3
– Discussion #4
– Chapter 11 Test
• Due on Sunday
– ***Open up Final***
1-53

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