FINANCIAL MANAGEMENT

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1 100 Arbor Drive, Suite 108 Christiansburg, VA Voice: FAX: Providing Professional Business Advisory & Consulting Services Douglas L. Johnston, II FINANCIAL MANAGEMENT ADVICE ON BUDGETING, CASH MANAGEMENT, AND FINANCIAL ANALYSIS

2 CONTENTS Budgeting 1 Cash Management 3 Financial Analysis 4 Sample Budget and Analysis 5

3 BUDGETING PROFITABILITY PURPOSE: A budget is a quantitative plan of expected results of business operations during a future time period PRINCIPLES OF BUDGETING: GOAL ORIENTED REALISTIC DETAILED ADVANTAGES OF BUDGETING PROFITABILITY: Facilitates informed financial decisions and helps prevent crises Provides basis for third parties to evaluate financing/investing opportunities Quantifies business opportunities and efficiency in use of limited resources Allows advance planning for income tax burden and business succession Creates awareness of keys to success of operations Creates framework for team performance evaluations BASIC BUDGETING METHODS: HISTORICAL DATA - Based on experience from past accounting periods MARKET DATA - Based on market/industry research CONSTRAINTS - Based on efficient allocation of limited resources 1

4 BUDGETING CASH FLOW PURPOSE: A cash flow budget may be the most important financial management tool for a small business. It is a forecast of cash requirements based on when cash is expected to be received and when obligations must be paid. ADVANTAGES OF BUDGETING CASH FLOW: Reflects the cash position of the business rather than the profitability Recognizes all cash transactions including balance sheet items like purchase of inventory and repayment of loans Enables business owner to forecast working capital needs and plan for shortfalls in cash resources Predicts when debt will be repaid and when cash will be available for distribution to owners or reinvestment 2

5 CASH MANAGEMENT PURPOSE: Cash management maximizes the efficient use of the cash resources available to a business. CASH MANAGEMENT STRATEGIES: Analyze your balance sheet for hidden cash. Examples: Minimize noncash assets Manage liabilities Financing Collect accounts receivable from customers Sell accounts receivable to third parties Reduce inventory and shift toward just in time method Sell non-essential fixed assets Consider leasing vs. owning vehicles and equipment Borrow against cash surrender value and other cash reserves Hold cash as long as possible before paying obligations Take advantage of discounts and avoid late payment penalties Minimize interest costs Consider new financing and/or investors 3

6 FINANCIAL ANALYSIS VERTICAL OR COMMON SIZE ANALYSIS: Vertical analysis converts all amounts on the financial statements to relative percentages of a base number (generally assets or revenues) for the same time period. HORIZONTAL ANALYSIS: Horizontal analysis compares amounts on the financial statements to corresponding amounts for prior accounting periods and/or similar organizations. RATIO ANALYSIS: Ratio analysis uses a variety of statistical measures to objectively evaluate relationships among items on the financial statements and identify trends. NON-FINANCIAL PERFORMANCE ANALYSIS: Non-financial analysis seeks to identify key performance indicators for a particular business operation and track changes in the indicators over time. Examples: Response rate on advertising and marketing Percentage of contacts converted to sales Customer retention rate Average dollar amount per transaction 4

7 SAMPLE BUDGET VERTICAL FINANCIAL STATEMENT ANALYSIS HORIZONTAL FINANCIAL STATEMENT ANALYSIS FINANCIAL RATIOS AND CASE STUDY 5

8 Pro Forma Cash Flow, John s Jewelry Work Sheet Percent of Total Sales Total Monthly Sales 18,314 18,314 18,314 27,470 27,470 50,362 27,470 27,470 27,470 59,519 77,833 77,833 J F M A My J Jy Au S O N D Total Cash Receipts Cash Sales 12,820 12,820 12,820 19,229 19,229 35,254 19,229 19,229 19,229 41,663 54,483 54, ,488 Collections 0 5,494 5,494 5,494 8,241 8,241 15,109 8,241 8,241 8,241 17,856 23, ,002 Total Cash In 12,820 18,314 18,314 24,723 27,470 43,495 34,388 27,470 27,470 49,905 72,339 77, ,490 Expenditures Merchandise 7,325 7,325 7,325 10,988 10,988 20,145 10,988 10,988 10,988 23,808 31,133 31, ,136 Lease 2,900 2,900 2,900 2,900 2,900 2,900 2,900 2,900 2,900 2,900 2,900 2,900 34,800 Electric ,900 Water, Trash Insurance ,800 Mgt. Salary 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 3,000 36,000 Payroll 2,500 2,500 2,500 3,500 3,500 3,500 3,500 3,500 3,500 9,000 9,000 9,000 55,500 Payroll Taxes 1,670 1,610 1,610 2,136 2,076 2,991 2,076 2,076 2,136 3,908 4,640 4,640 31,568 Telephone Security ,080 Office Expense Prof. License Loan Payment 3,220 3,220 3,220 3,220 3,220 3,220 3,220 3,220 3,220 3,220 3,220 3,220 38,640 Accountant ,560 Advertising ,000 1,000 1,000 5,925 Total Expenditures 22,255 21,595 21,595 27,384 26,724 36,916 26,724 26,724 27,384 47,550 55,608 55, ,069 Cash Flow (9,435) (3,281) (3,281) (2,661) 746 6,578 7, ,354 16,730 22,224 38,422 Cumulative CF (9,435) (12,717) (15,998) (18,659) (17,912) (11,334) (3,720) (2,974) (2,887) (533) 16,197 38,422 6

9 ABC COMPANY BALANCE SHEET Vertical Analysis ASSETS Amount Percent CURRENT ASSETS Cash $ 70, % Accounts receivable 330, Inventory 400, Prepaid expenses 20, Total current assets 820, PROPERTY, PLANT, AND EQUIPMENT Machinery and equipment 175, Furniture and fixtures 75, , Less accumulated depreciation 80, , OTHER ASSETS Goodwill 10, Total assets $ 1,000, % LIABILITIES AND STOCKHOLDERS EQUITY CURRENT LIABILITIES Accounts payable 280, Accrued expenses 20, Notes payable 100, Current maturities of long-term debt 40, Accrued income taxes 10, Total current liabilities 450, LONG-TERM DEBT 160, DEFERRED INCOME TAXES 10, Total liabilities 620, STOCKHOLDERS EQUITY Common stock 10, Additional paid-in capital 40, Retained earnings 330, Total stockholders equity 380, Total liabilities and stockholders equity $ 1,000, % 7

10 ABC COMPANY INCOME STATEMENT Vertical Analysis Amount Percent SALES $4,325, % COST OF GOODS SALES 2,950, Gross profit 1,375, SELLING, GENERAL AND ADMINISTRATIVE EXPENSES 1,209, OTHER EXPENSES Interest 28, Income before income taxes 138, INCOME TAX EXPENSE 41, Net income 97, % RETAINED EARNINGS Beginning of year 233,000 End of year $ 330,000 8

11 ABC COMPANY BALANCE SHEET Horizontal Analysis ASSETS Industry Year 2 Year 1 CURRENT ASSETS Cash 6.60% 7.00% 3.70% Accounts receivable Inventory Prepaid expenses Total current assets PROPERTY, PLANT, AND EQUIPMENT Machinery and equipment Furniture and fixtures Less accumulated depreciation OTHER ASSETS Total assets % % % LIABILITIES AND STOCKHOLDERS EQUITY CURRENT LIABILITIES Accounts payable Accrued expenses Notes payable Current maturities of long-term debt Accrued income taxes Total current liabilities LONG-TERM DEBT DEFERRED INCOME TAXES Total liabilities STOCKHOLDERS EQUITY Common stock Additional paid-in capital Retained earnings Total stockholders equity Total liabilities and stockholders equity % % % 9

12 ABC COMPANY INCOME STATEMENT Horizontal Analysis Industry Year 2 Year 1 SALES % % % COST OF GOODS SALES Gross profit SELLING, GENERAL AND ADMINISTRATIVE EXPENSES OTHER EXPENSES Interest Income before income taxes 2.80% 3.20% 1.10% 10

13 RATIOS INDICATING EQUITY POSITION Description Calculation Indication Debt/Equity Total Liabilities Reflects financial strength Equity and cushion for creditors. Return on equity Net income The return on the resources Stockholders equity provided by the shareholders. Sales to owners equity Sales (net) The utilization of owner capital. Owners equity Fixed assets to owners Fixed assets (net) Extent of capital invested equity Owners equity in fixed assets. Sales to fixed assets Sales (net) Management efficiency in (plant turnover) Fixed assets (net) using plant properties. 11

14 RATIOS INDICATING INCOME POSITION AND OPERATING RESULTS Description Calculation Indication Net income to net sales Net income The net productivity of Net sales each dollar of net sales. Income before taxes Income before taxes Management effectiveness to total assets Total assets in using available resources. Gross margin ratio Gross profit (margin) The portion of net sales Net sales remaining after cost of sales expenses. Income before interest Income before interest and taxes and taxes to interest Annual interest expense expense Ability to meet interest charges. Cash flow to current Net income + depreciation, portion of debt depletion and amortization Ability to retire current portion Current portion of debt of debt. 12

15 RATIOS INDICATING CURRENT POSITION Description Calculation Indication 1. Current Current assets Ability to meet current Current liabilities obligations from current assets as a going concern. 2. Quick Liquid assets Ability to meet sudden Current liabilities demands upon current assets. 3. Receivables a. receivables turnover Net credit sales Efficiency of collection. Net average receivables b. Average collection 365 days The average number of period Receivables turnover days to collect receivables. c. Days receivable Ending receivables x 365 days Number of days sales uncollected Net credit sales uncollected. 4. Inventory a. Merchandise Cost of goods sold turnover (retail) Average merchandise inventory Effectiveness of inventory b. Finished goods Cost of goods sold management. turnover Average finished goods (manufacturing) inventory c. Days supply in Ending inventory X 365 days Number of days supply in the inventory Cost of goods sold ending inventory. May indicate over- or under-stocking. 5. Working capital turnover Net sales Adequacy of and changes in Average working capital working capital level. 13

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