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 forecast 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.