Chapter 17: Managing Business Finances

Financial Management

The Purpose of the Financial Plan

• When starting a new business or project at an existing firm, managers must determine if it is likely to be financially viable.
• A $financial plan$ is a set of documents that outline the essential financial facts about the new venture
    * A financial plan can also be used to attract investors
• An effective financial plan:
    * identifies the assets that need to be purchased.
    * describes the amount of money a business needs to start and \n operate.
    * describes the expenses the business will incur and explains \n how a business will cover its expenses.
    * describes how the business will document and report \n financial records.
    * forecasts finances to project future profitability.
    * explains how the business will acquire money to grow or expand
• A financial plan estimates the amount of capital the business will need.
    * $Capital$ is money supplied by investors, banks, or owners of a business.
    * Start-up capital is the money used to pay for the various assets and expenses of a new venture or business.
• A financial plan explains how a business will manage its records
• A financial plan includes financial forecasts.
    * A $financial forecas$$t$ is an estimate of a business’s financial outlook for each of the next few years
• Planned growth can be very rewarding.
• Unplanned growth can be chaotic.
• The financial plan should explain the company’s plans for financial growth.

Budgets

• Financial statements indicate the financial condition of a firm in a past period.
• However, a budget helps guide its future.
• A $budget$ is a plan specifying how money will be used or spent during a particular period.
    * Budgeting helps business owners predict how much money the business will need.
• There are three main types of budgets.
    * A start-up budget is a plan for your income and expenses from the time you start a business to estimated time it will make a profit.
    * A cash budget is a plan for the actual money the business owner spends on a daily, weekly, or monthly basis.
    * An operating budget is a plan for the amount expected to be spent and earned over a given period of time, usually six months or a year.

Accounting

Accounting for Business

• $Accounting$ is the systematic process of recording and reporting the financial position of a person or an organization.
    * The accounting system is designed to collect, record, and report financial transactions that affect the operation of a business.
• An accountant maintains and reviews business records.
• However, many larger companies hire accounting firms to manage or audit their financial records.
    * An audit is a review of accounting records and procedures.
• The biggest accounting firms are known as the “Big Four.”
    * PricewaterhouseCoopers®, Deloitte Touche Tohmatsu®, Ernst & Young®, and KPMG® are accounting firms that operate worldwide.
• All accountants use the same set of rules, called $generally accepted accounting principles$, or $GAAP$ (pronounced gap), to prepare reports.
• Financial reports are summarized information about the financial status of a business

Property Ownership and Control

• The right to own property is basic to a free enterprise system.
• $Property$ is anything of value that is owned or controlled.
    * Dollar amounts measure both the cost of the property and the property rights, or financial claims to the property.
• $Assets$ are property and other items of value owned by a business.
• They are either current or fixed.
• $Current assets$ are assets that are either used up or converted to cash during the normal cycle of the business.
    * The normal cycle is usually one year.
    * Cash, supplies, merchandise, and accounts receivable are all current assets.
      * $Accounts receivable$ is the total amount of money owed to a business.
        * It represents money to be received in payments after goods or services are sold on credit.
• $Fixed assets$ are items of value that will be held for more than one year.
    * These include equipment and buildings.
    * The accounting term for the financial claims to all assets is equity.
      * $Equity$ is the present value of an asset less all claims against it.
      * $Liabilities$ are creditors’ claims to the assets of a business.
        * They are the debts of a company
• $Accounts payable$ represents the short-term liabilities that a business owes to creditors.
• Owner’s equity is an owner’s claim to the assets of the business.
• It is also referred to as the owner’s capital in the business.

The Accounting Equation

• The accounting equation ensures that all accounting records will be correct.
• The $accounting equation$ is a rule that states that assets must always equal the sum of liabilities and owner’s equity.
• The assets side of the equation shows the value of everything that the business owns or possesses.
• The other side shows the rights to those assets.
• Liabilities are the rights that creditors have to the assets.
• Owner’s equity shows the rights that the owner has to the assets.

Financial Statements

• The accounting system is designed to generate financial statements and reports.
• $Financial statements$ are documents that summarize the changes resulting from business transactions that occur during an accounting period.
    * An accounting period is the period of time reflected by an accounting report.
• The $income statement$ is a report of the revenue, expenses, and net income or net loss over an accounting period.
    * It is sometimes called a profit and loss statement.
    * Income statements for different types of business operations vary in content.
      * A service business would have sales, expenses, and net income.
      * A merchandising business would also include the cost of merchandise purchased for resale.
• A $balance sheet$ is a report of the balances in all assets, liability, and owner’s equity accounts at the end of an accounting period.
• $Cash flows$ are the money that is available to a business at any given time.
• The $statement of cash flows$ is a financial report that shows incoming and outgoing money during an accounting period (often a month, quarter, or year).
    * One reason that a cash flow statement is very important is that firms can run out of cash even when they make a profit.
• Today, most companies use computer programs to simplify their accounting procedures.
• Microsoft Excel is a spreadsheet application that is commonly used in business.
• Accounting software such as Peachtree Accounting and QuickBooks are programs that help people and businesses manage their finances.