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SHS Business Finance Chapter 3

Having a financial plan helps businesses set goals and stay on track to meet them. Creating a financial plan involves calculating startup costs, forecasting profits and losses, cash flows, and break-even points. It also requires creating budgets like master, operating, cash flow, sales, and production budgets to project finances. Working capital measures short-term financial health and involves managing current assets like inventory and accounts receivable efficiently. Maintaining adequate working capital through ratios helps ensure short-term obligations can be met.

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186 views17 pages

SHS Business Finance Chapter 3

Having a financial plan helps businesses set goals and stay on track to meet them. Creating a financial plan involves calculating startup costs, forecasting profits and losses, cash flows, and break-even points. It also requires creating budgets like master, operating, cash flow, sales, and production budgets to project finances. Working capital measures short-term financial health and involves managing current assets like inventory and accounts receivable efficiently. Maintaining adequate working capital through ratios helps ensure short-term obligations can be met.

Uploaded by

Ji Baltazar
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FINANCIAL PLANNING

TOOLS AND CONCEPTS


“Having a Financial Plan or creating a financial plan helps you see
the big picture and set long and short-term business goals, a crucial
step in mapping out your financial future. When you have a
financial plan, it's easier to make financial decisions and stay on
track to meet your goals”
FINANCIAL PLANNING PROCESS
Step 1: Calculate set-up costs
◦ Set-up costs or start up for another operating period will include:
◦ Accounting fees
◦ Registrations and licenses/or renewal
◦ Equipment and fit out
◦ Initial working capital

Step 2: Profit and loss forecast


◦ Compare potential sales revenue to cost of goods sold and fixed costs of doing business
◦ Calculate likely margins and put your pricing model to the test
Step 3: Cash-flow forecast
◦ New businesses or another operating period often need cash to build the capacity necessary to service
customers
◦ Customers may be slow to pay
◦ The resulting cash-flow gap could leave you vulnerable if you’re not prepared

Step 4: Balance sheet forecast


Step 5: Break-even analysis
BUDGET AND BUDGET PREPARATION
Budgeting is the process of creating a plan to spend your money. This
spending plan is called a budget.

WHY BUDGETING IS IMPORTANT?


Types of Budgets for Businesses
Master Budget - is an aggregate of a company's individual budgets designed to
present a complete picture of its financial activity and health. The master budget
combines factors like sales, operating expenses, assets, and income streams to
allow companies to establish goals and evaluate their overall performance, as
well as that of individual cost centers within the organization. Master budgets
are often used in larger companies to keep all individual managers aligned.
Operating Budget - is a forecast and analysis of projected income and expenses
over the course of a specified time period. Operating budgets are generally
created on a weekly, monthly, or yearly basis. A manager might compare these
reports month after month to see if a company is overspending on supplies.
Cash Flow Budget -is a means of projecting how and when cash comes in and
flows out of a business within a specified time period. It can be useful in helping
a company determine whether it's managing its cash wisely. Cash flow budgets
consider factors such as accounts payable and accounts receivable to assess
whether a company has ample cash on hand to continue operating, the extent
to which it is using its cash productively, and its likelihood of generating cash in
the near future.
Sales Budget - is the first and basic component of master budget and it shows the expected
number of sales units of a period and the expected price per unit. It also shows total sales which
are simply the product of expected sales units and expected price per unit.

Production Budget - is a schedule showing planned production in units which must be made by
a manufacturer during a specific period to meet the expected demand for sales and the planned
finished goods inventory.
◦ Planned Production in Units = Expected Sales in Units + Planned Ending Inventory in Units − Beginning Inventory
in Units
Budgeted Income Statement
The budgeted income statement contains all of the line items found
in a normal income statement, except that it is a projection of what
the income statement will look like during future budget periods. It is
compiled from a number of other budgets, the accuracy of which
may vary based on the realism of the inputs to the budget model.
Projected Balance Sheet
communicates expected changes in future asset investments,
outstanding liabilities and equity financing.
A projected balance sheet provides the most relevant financial
information needed in the business planning process.
A projected balance sheet, also referred to as pro forma balance
sheet, lists specific account balances on a business' assets, liabilities
and equity for a specified future time.
WORKING CAPITAL (concepts/tools and
management)
Working capital is a measure of both a company's efficiency and its short-term
financial health. Working capital is calculated as:
◦ Working Capital = Current Assets - Current Liabilities

The working capital ratio (Current Assets/Current Liabilities) indicates whether


a company has enough short term assets to cover its short term debt.
Things to Remember about working capital ratios:
If the ratio is less than one then they have negative working capital.
A high working capital ratio isn't always a good thing, it could
indicate that they have too much inventory or they are not investing
their excess cash
Working Capital Management
Working capital management refers to a company's managerial
accounting strategy designed to monitor and utilize the two
components of working capital, current assets and current liabilities,
to ensure the most financially efficient operation of the company.
The primary purpose of working capital management is to make sure
the company always maintains sufficient cash flow to meet its short-
term operating costs and short-term debt obligations.
Concepts of Working Capital
Management
Working capital management commonly involves monitoring cash
flow, assets and liabilities through ratio analysis of key elements of
operating expenses, including the working capital ratio, collection
ratio and the inventory turnover ratio. Efficient working capital
management helps with a company's smooth financial operation,
and can also help to improve the company's earnings and
profitability. Management of working capital includes inventory
management and management of accounts receivables and accounts
payables.
Elements of Working Capital
Management
working capital ratio = current assets / current liabilities

*it test the fundamental health of the company


*it indicates the company’s ability to successfully meet all of its
short-term financial obligations.
collection ratio - also known as the average collection period ratio, is
a principal measure of how efficiently a company manages its
accounts receivables.

◦ collection ratio = (number of days in an accounting period, such as one month)*(average amount of
outstanding accounts receivables) / net credit sales.

◦ ***The lower a company's collection ratio, the more efficient is its cash flow.
Inventory management
To operate with maximum efficiency and maintain a comfortably high level of working capital, a
company has to carefully balance sufficient inventory on hand to meet customers' needs while
avoiding unnecessary inventory that ties up working capital for a long period of time before it is
converted into cash.

inventory turnover ratio = Revenues / Inventory Cost


◦ *A relatively low ratio compared to industry peers indicates inventory levels are excessively
high, while a relatively high ratio indicates the efficiency of inventory ordering can be
improved.

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