Creating a Successful Financial Plan

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Net profit margin = net income divided by annual sales

Financial Management- process provides entrepreneurs with relevant financial info in an easy-to-read format on a timely basis. Allows entrepreneurship to know how businesses are doing financially/ why they are performing that way

Basic Financial Statements

• Balance sheet- financial statement that provides a snapshot of business financial position. estimating its worth on a given date (Built on fundamental accounting equation: Assets= Liabilities + Owners equity)

  • Current assets- cash and convertible cash items within company's operating cycle or one year

  • Fixed assets- assets acquired for long term use in a business

  • Liabilities- Creditors claims against a company's assets

  • Current Liabilities- those debts that must be paid within one year/ normal operating cycle

  • Long term Liabilities- liabilities that come due after one year

  • Owners Equity- the value of the owner's investment

• Income Statement- financial statement that reps a moving picture of a business/ comparing expenses against its revenue over a period of time to show its net income or loss

  • Cost of goods sold- the total cost (shipping of merchandise sold during the accounting period)

  • Gross profit margin- gross profit divided by net sales

  • Operating expenses- costs that contribute directly to the manufacture and distribution of goods

  • Customer Profitability Map- finding out if the customers are profitable or costing you money.

    • High liability- profitable but difficult to deal with (good fit for bus)

    • Target more- customers resonate with comp. and highly profitable (best)

    • Avoid- difficult to deal with/ absorb time and resources/ not profitable

    • Cross sell- good fit for company but produce low profits (upsell?)

• Statement Cash Flows- financial statement showing changes in company's working capital from the beginning of the year by listing both the sources and the uses of those funds

Ratio analysis- a method of expressing the relationship between any two accounting elements that allows business owners to analyze their company's financial performances

12 Key ratios (Division symbol is labeled as a " / ")

• Liquidity ratios tell whether a small bus. will be able to meet its short term financial obligations

  • Current Ratio- measures Sm. firm's solvency by indicating its ability to pay current liabilities out of current assets (current ratio = current assets/ current liabilities)

  • Quick Ratio- conservative measure of firms liquidity/ measuring the extent to which its most liquid assets cover its current liabilities (quick ratio = quick assets/ current liabilities)

• Leverage Ratios- measure the financing supplied by firm's owners against that supplied by creditors. They are the gauge of the depth of company debt

  • Debt Ratio- measures % of total assets financed by a company's creditors compared to its owners (Debt ratio = liabilities (total debt)/ total assets)

  • Debt to net worth (equity) ratio- express the relationship between the capital contributions from creditors/ those from owners and measures how highly leveraged a company is (DTNW Ratio = Liabilities (total debt) / tangible net worth)

  • Time interest earned ratio- measures a small firms ability to make interest payments on its debt (TIE Ratio = earnings before interest and taxes (EBIT) / total interest expense)

• Operating Ratios- help an entrepreneurs evaluate small company performance/ how effectively employs resources

  • Average inventory turnover ratio- measures number of times its average inventory is sold out over time (AIT Rate = cost of goods sold / average inventory)

  • Average collection period ratio- measures the umber of days it takes to collect accounts receivable (ACP Ratio = days in accounting period / receivables turnover ratio)

  • Average payable period ratio- measures number of days it takes a company to pay accounts payable (APP Ratio = purchases / accounts payable)

    • Float- net number of days of cash flowing into/ out of company

    • Float = days payable outstanding (DPO)- days sales outstanding (DSO)

  • Total asset turnover Ratio- measures company ability to generate sales in relation to asset base (TAT Ratio = net sales / net total sales

• Profitability Ratios- indicate how effectively a small company is being managed

  • Net profit on sales ratio- measures a company's profit per dollar of sales (net profit/ net sales)

    • Operating leverage- increases operational efficiency that expenses as percentage of sales revenue decline

  • Return on assets ratio- measure the owners rate of return on investment (net profit/ net worth)

Interpreting Business Ratios- measures performance/ point out potential problems before becoming critical

• (Critical numbers or key performance indicators KPI) measures financial/ operating aspects of comp perf.

• Financial Benchmarking- entrepreneurs compare company key financial indicators to averages from many comps of similar size in same industry to identify problem areas that a company's history may not show

  • effective way to set KPIs to ensure success/ exceed performance/ find deviations

Break even analysis (B.E. Point- level of operation (sales price or production quantity) company never earns nor losses profit)

• Calculating break even point with fixed exp. (non varying costs) and variable expenses (change w./volume)

• Step 1-4: forecast expenses/ variable or fixed/ calculate ratio- variable expenses to net sales/ break even point…

  • ….formula (Break even sales = total fixed costs / contribution margin expressed as percentage of sales)

  • Adding profit (sales = (total fixed expenses + desired net income) / contribution margin as percentage sales

  • BEP in units (BE Volume = total fixed costs / sales price per unit - variable cost per unit)

  • Contribution margin = price per unit - variable cost per unit

  • BE volume = total fixed costs / per unit contribution margin

  • Sales = total fixed costs + desired net income / per unit contribution margin

Constructing Break even chart- opportunity for integrated analysis of sales volume/ expenses/ income/ etc.

• X-axis: mark a scale measuring sales volume in $ (or volume)

• Y-axis: mark a scale measuring income and expenses in dollars

• Draw fixed expense line intersecting vertical axis at proper $ level parallel to X axis

• Draw total expense line that slopes upward beginning at fixed cost line intersection with Y axis

  • total exp. = fixed expenses + variable expenses expressed as percentage of sales X sales level

• From 0, draw a 45* Revenue line showing where total sales volume = total income

• locate break even point by finding intersection of total expense line and revenue line