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Finance 101 for StartupsA crash course in financial management for startup

businesses

Presented by: Matt Evans

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• Module 1 – How Accounting Works

• Module 2 – Reading the Financial Statements

• Module 3 – Analyzing the Financial Statements

• Module 4 – Additional Financial Analysis

• Module 5 – Evaluating Long Term Investments

• Module 6 – Advanced Concepts in Finance

• Module 7 – Business Analysis

Outline

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Workshop Roadmap Overview

Accounting

Financial Statements

Analyze the Financials

Start with Accounting

Manage the Business

Generate the Financial

Statements

Apply Analytical Tools and

Techniques

Make Objective Decisions

per the Numbers

You as the Business Owner should spend time measuring

and managing the business based on the numbers

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Module 1

How Accounting Works

Overview of how the accounting process works at a detail

transaction level

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• All transactions pass through your Check Book

• All transactions must be recorded

• Businesses have a wide range of transactions:

• Customers buy your products or services = Cash Inflows

• Vendors and Employees must be paid = Cash Outflows

Think in Terms of Your Check Book Module 1

Cash Inflows

(Deposits)

Cash Outflows

(Checks)

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Most transactions are cash basis (pass through your cash account), but . . .

• Accrual Accounting recognizes revenues when earned before you collect

the cash – Accounts Receivable Account

• Accrual Accounting recognizes expenses when incurred before you make

payment – Accounts Payable Account

• Cash Basis – Only post transactions when they go in and out of your

Check Book

• Tracking – Make sure you can control and track the money you owe

others in the future and collect all money owed to you (customers pay

on time when due).

Accrual Accounting is Preferred Module 1

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Simple Cash Basis Accounting Spreadsheet Module 1

Simple Spreadsheet for Cash Basis Accounting

Year:

Date Description Name Amount Category RefRevenues: (Cash Collected from Sales to Customers)

2/8/2018 Sold 18 bars soap at Eastern Market Various Walk By Traffic 54.00$ Sales Revenue

2/17/2018 Sold 20 bars soap to Rosa Ela Shop Rosa Ela Shop in College Prk 40.00$ Sales Revenue

2/22/2018 Sold 22 bars soap at Dupont Circle Various Walk By Traffic 66.00$ Sales Revenue

Feb-18 Online Orders of Soap - Etsy Various per Etsy 22.00$ Sales Revenue

TOTAL REVENUES 182.00$

Expenses: (Cash Paid for all business related expenses)1/6/2018 Soap Materials Sarah's Craft House (110.09)$ Materials Expense

1/15/2018 Booth Materials for Markets M-Displays Inc (75.00)$ Marketing Expense

1/22/2018 Promotion Flyers Office Max (36.55)$ Marketing Expense

2/6/2018 License Fee to County DC Dept of Cons / Reg Affairs (115.00)$ Legal Expenses

TOTAL EXPENSES (336.64)$

PROFIT OR (LOSS) (154.64)$

Setup and

maintain for

each calendar

year to comply

with filing your

tax return

Once you begin

earning profits,

you are liable for

paying estimated

taxes during the

calendar year

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How the Accounting Model Works

1. Assets – Resources of the Business

2. Liabilities – Obligations

3. Equity – Investments by Owners

4. Revenues – Inflows from Sales

5. Expenses – Outflows for Costs

Balance Sheet

IncomeStatement

The Accounting Model can be summarized through two equations:

Assets = Liabilities + EquityRevenues – Expenses = Profit or (Loss)

KEY POINT: Businesses invest in assets two

ways: Liabilities and Equity. Assets exist for

one single reason: To Generate Revenues

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Chart of Accounts

Cash Money in the bank

Accounts Receivable Amounts owed to the company for sales

Inventory Pants, Shirts, Hats, Shoes, Socks, Belts, etc.

Furniture and Fixtures Storefront assets such as tables, racks, chairs, etc.

Accounts Payable Amounts that must be paid to vendors / suppliers

Loans Payable Amounts due to banks

Long Term Debt Amounts due to investors or bank against long term assets

Owners Capital Account Amount invested by the owner of the business

Retained Earnings Profits held by the business for reinvesting

Sales Revenue Amount of revenues from selling products / services

Cost of Goods Sold Cost of inventory that has been sold

Administrative Expense Cost of office support personnel

Selling and Marketing

Expense

Advertising, Sales Commissions, Trade Show Displays, etc.

Utility Expense Gas, Water & Electric expenses

The Chart of

Accounts is the

back-bone for

capturing all

transactions –

some software

programs may

refer to it as a

“Category”

You MUST

classify all

transactions;

otherwise you

have no basis for

reporting.

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Most Transactions Go Thru Cash

1-6-2014 Purchase office supplies

1-1-2014 Beginning Balance

Account Title: Cash

1-16-2014 Run Bi Weekly Payroll

1-12-2014 Deposit payment from customer

1-26-2014 Pay Monthly Electric Bill

1-22-2014 Insurance Premium Paid

$ 4,220.55

$ 142.20

1-31-2014 Ending Balance

$ 3,600.00

$ 2,640.00

$ 265.00

$ 516.30

$ 4,257.05

Debit (Left) Credit (Right)

Let’s walk through some entries . . .

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Accounting is Dual (Two Sides)

Five groups of accounts make up the

Accounting Model. If you want to

increase or decrease the account

balance, you either Debit (left side) or

Credit (right side) the account when you

post an entry.

This can be very confusing – this is why

you might want to enlist an Accountant

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Summarize the Accounting Process

Accounting

System

Financial

Statements

End of Period

Accrual Entries

Transactions

(Mostly Cash Basis)

Post to General

Ledger Accounts

Balance

Sheet

Income

Statement

Economic Activity of the

Business

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Recap Some Important Points

1. Most transactions pass through the Cash Account. Make sure you post all transactions that go through your Business Bank Account.

2. You must classify all transactions according to how you want to report financial results. Chart of Accounts

3. Accounts capture transactions. There are five major groups of accounts: Assets, Liabilities, Equity, Revenues, and Expenses

4. The five groups of accounts is the basis for presenting the financial statements of a business: Balance Sheet and Income Statement.

5. Financial Statements are prepared as of a cut off date (such as March 31st) presenting the balances as of this date.

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Comprehensive Exercise

Let’s go through a startup business and see how accounting transactions get posted over time

Three phases take place over time when starting a business:1. Fund the Business – Financing Transactions2. Acquire the Right Mix of Assets to Generate Revenues –

Investment Transactions3. Generate Revenues and Expenses – Operating Transactions

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Popular Accounting Software Programs

Quick Books > https://quickbooks.intuit.com/Fresh Books > https://www.freshbooks.com/Wave > https://www.waveapps.com/Billy > https://billyapp.com/Zip Books > https://zipbooks.com/Express Accounts > https://www.nchsoftware.com/accounting/index.htmlKashFlow > https://www.kashflow.com/GoDaddy Accounting > https://www.godaddy.com/email/online-bookkeepingClear Books > https://www.clearbooks.co.uk/Less Accounting > https://lessaccounting.com/Zoho Books > https://www.zoho.com/us/books/Xero > https://www.xero.com/us/

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Module 2

Financial Statements

Read and understand three financial statements

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Three Financial Statements Module 2

• Financial condition of a company at a given point in time

• Consists of three components: Assets, Liabilities and Owners Equity

• Profit or Loss of a company over a period of time

• The critical indicator of company performance!

• Consists of two components: Revenues and Expenses

• Sources and uses of cash over a period of time

• Consists of three activities: Operating, Investing, and Financing

Income

Statement

Statement of Cash Flow

Balance

Sheet

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Balance Sheet Module 2

Assets and Liabilities

are divided into two

groups: Current and

Long-Term

The Balance Sheet is

prepared as of a cut-

off date usually on a

calendar year basis

(January 1 thru

December 31)

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Important Points – Balance Sheet Module 2

1. Current Assets – Does not generate a return for the business. Goal is to turn this

over and run it through cash.

2. Long Term Assets – Generates a return, drives our revenues and is important to

growth of the business

3. Liabilities in Relation to Equity – The more liabilities we have and the less equity

we have, the higher the risk of the business – inability to meet our obligations

KEY POINT: We will learn how to use ratios to assess

these important points later in this workshop

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Income Statement Module 2

Gross Profit or Gross

Margin divided by Total

Sales = Gross Margin

Percent

You need to be at 35%

or 40% minimum to

earn a profit

KEY POINT:

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Statement of Cash Flow Module 2

• Cash received from customers

• Payments made to vendors and employees

• Tax payments, rent payments, utilities, etc.

• Invest in Real Estate

• Sell Off Equipment

• Secure Long Term Financing (Loan)

• Distribute Income to Owners

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Format – Statement of Cash Flow Module 2

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Example – Statement of Cash Flow Module 2

KEY POINT: Must get to positive Operating

Cash Flow (Stage 3)

Stage 1 – Fund the Business

Stage 2 – Make the necessary

investments to generate revenues

Stage 3 – Sell to Customers and

generate Revenues above

Expenses

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Exercise 1 – Generate Financial Statements Module 2

Close out the accounting period and generate the Balance Sheet per the balances that are outstanding in the various general ledger accounts

Two handouts – Financial Statement Template and Account Activity for the Period

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Extra Tips - Taxation Module 2

1. Profits are subject to taxation2. Most businesses are pass through entities (such as LLC) – Profits pass through to the

Owners who get taxed on the Profits3. Three forms of taxation on Profits to the Owner(s):

1. State Income Tax (personal tax rate)2. Federal Income Tax (personal tax rate)3. Self Employment Tax (12.4% social security + 2.9% medicare)

Due Dates for 2019 Estimated Quarterly Tax Payments:

Q1: Monday, April 15, 2019 (January – March)Q2: Monday, June 17, 2019 (April – May)Q3: Monday, September 16, 2019 (June – August)Q4: Wednesday, January 15, 2020 (September – December)

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Additional Links Module 2

My Own Online Short Courses:

https://exinfm.com/training/

Accounting in One Hour > http://inanhour.com/

Learn Accounting Online > https://www.accountingcoach.com/

Accounting Library >

http://www.businessbookmall.com/Accounting%20Internet%20Library.htm

Simple Accounting Studies > http://www.simplestudies.com/

Financial Tutorial > http://www.almaris.com/fact/fact-contents.htm

Principles of Accounting Online > https://www.principlesofaccounting.com/

Understanding Financial Statements > http://bizzer.com/images/Financial/index.html

Take the Fundability Quiz > https://www.businessloans.com/fundability/

How Contributions and Distributions Work for an LLC >

https://www.thebalancesmb.com/llc-member-capital-contributions-398638

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Take a Break

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Module 3

Analyzing the Financials

Apply analytical techniques to better understand the financial

statements

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Financial Terminology Module 3

Cash Flow – The amount of cash receipts and disbursements that flows in and out of the business over time. We want more cash coming in then cash going out.

Debt – Liabilities such as Loans, Mortgages, Bonds, and Commercial Paper (large public corporations). High debt levels equates to high risk.

Equity – The amount of funds invested by owners of the business + profits that are retained by the business for future growth.

Liquidity – The ability of a company to convert assets into cash for meeting short-term obligations. It is important to have sufficient liquidity to meet your short term obligations.

Leverage – How a company finances its assets; debt vs. equity

Earnings = Net Income = Profits – The residual income remaining after all expenses.

Rate of Return – How much return does the investment generate for the business; residual income after all costs. It is important for long term assets to generate positive returns.

Turn Over – The ability of a company to turn over and convert an asset into something else, such as sales or cash. It is important to turn over current assets into cash.

Working Capital – The funds available to the business within the current operating cycle, expressed as current assets in excess of current liabilities.

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Important Concept - Turnover Module 3

Accounts

Receivable (Send a bill to the customer)

Cash

Inventory -Appliances

Sale on Credit

Eventually everything will flow through your cash account!

KEY POINT: Any asset that is “current” needs to turnover – the shorter the

cycle the better which in turn reduces

the need to finance the current operations of the business. Try and

collect the money at the Point of Sale – No Need to Collect Money

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Three Analytical Techniques Module 3

Ratio Analysis• Divide one number by another number• Easy to benchmark and understand performance

Horizontal Analysis• Track Trends over Time• Key Trends include Sales Revenues, Net Income, Debt Levels

Vertical Analysis• Track Relationships (between accounts) over Time• Monitor proportion of debt and equity to assets – too much debt equates to higher

risk• Monitor proportion of non-operating expenses to operating expenses – most of your

costs should be operating with minimal non-operating expenses

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Four Types of Ratios Module 3

Liquidity Ability to meet short-term obligations of

the business

Leverage Degree to which assets are financed by

debt

Asset Management Management’s ability to manage

assets

Profitability Degree of profitability generated

KEY POINT: The Balance Sheet and the Income Statement are used to calculate ratios

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Liquidity Ratios Module 3

Current Ratio =

Quick Ratio =

Current Assets

Current Liabilities

Current Assets - Inventory

Current Liabilities

KEY POINT: Measures your ability to meet short-term obligations. Must be well

above 1.0 and above 2.0 to get a bank loan.

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Example of Current and Quick Ratios Module 3

$ 9,714,796 / $ 7,333,157

= 1.32

($ 9,714,796 – 2,724,783

– 2,982,049) / $ 7,333,157

= .95

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Ratios - Manage Current Assets Module 3

Accounts Receivable Turnover

Sales

Accounts

Receivable

Days Held in Accounts Receivable

A / R Turnover

365 Days

Inventory Turnover

Cost of Goods Sold

InventoryDays Held in Inventory

365 Days

Inventory Turnover

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Examples – Asset Management Ratios Module 3

Revenues

Sales Revenues $ 620,000

Investment Revenues 115,000

Total Revenues 735,000

Expenses

Cost of Goods Sold 380,000

Assets

Cash $ 5,600

Accounts Receivable 12,400

Inventory 39,000

Total Current Assets 57,000

Inventory Turnover

$ 380,000 / $ 39,000 = 9.7

How often does Inventory turn over during the year?

Number of Days Held in Inventory

365 / 9.7 = 37 days

How many days does it take to convert Inventory into Accounts Receivable?

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Measuring Risk – Debt vs. Equity Module 3

Debt to Equity

Debt to Assets

Total Liabilities

Owners Equity

Total Liabilities

Total Assets

Greater than 100% means company is using more debt than equity – more risk to the company

Greater than 50% means the company is using more debt than equity – more risk to the company

KEY POINT: The more liabilities (debt) you take on in relation to your own

investment (equity), the more riskier the business

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Examples of Leverage (Risk) Ratios Module 3

Proportion of Debt (Total Liabilities) to Equity in Funding the Business:

Debt / Equity or $ 1,000 / $ 500 = 2(you have 2 times more debt vs. equity)

Proportion of Debt used to finance the assets of the business:

Debt / Assets = $ 1,000 / $ 1,500 = .67% of financing of assets is in the form of debt (.33% is equity – owner)

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Know Your Margins Module 3

Profit Margin

Net Income

Sales

Operating Margin Sales

Operating Income

Return on Assets

Net Income

Total Assets (1)

Gross Margin

Gross Profit

Sales

(1) Average balances for the year are often used

KEY POINT: You DO NOT have a business unless you have sufficient margins –

you cannot realize a profit without a Gross Margin above 35%

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Examples of Margin Ratio Calculations Module 3

Gross Margin = $ 98,841 / $ 524,359 = 19%

Operating Margin = $ 26,765 / $ 524,359 = 5%

Profit Margin = $ 20,166 / $ 524,359 = 4%

In this example, it will be hard for the

business owner to make a solid profit to

invest back into the business or draw

money to cover personal expenses.

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Horizontal Analysis – Look at Trends Module 3

2004 2005 2006

Sales Revenues $ 120,000 $ 135,000 $ 146,000

Operating Expenses $ 68,000 $ 73,000 $ 78,000

Net Income $ 22,000 $ 26,000 $ 29,000

KEY POINT: Show

your trends lines

visually – much

easier to see what

direction you are

moving financially

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Vertical Analysis – Income Statement Module 3

%

Revenues Breakdown

Sales Revenues 4,000.00$ 100%

Total Revenues 4,000.00

ExpensesCost of Goods Sold 1,320.00 33%

Office Supply Expense 680.90 17%

Depreciation Expense 458.33 11%

Interest Expense 278.96 7%

Tax Expense 312.50 8%

Total Expenses 3,050.69 76%

Net Income 949.31$ 24%

Easy to

understand

your cost

breakdown

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Vertical Analysis – Balance Sheet Module 3

Assets %

Current Assets Breakdown

Cash 32,714.60$ 32%

Accounts Receivable -$ 0%

Inventory 9,680.00$ 9%

Total Current Assets 42,394.60 41%

Long Term Assets

Furniture & Fixtures 6,104.50 6%

Warehouse Facility 55,000.00$

Less Accumulated Depreciaiton 458.33$

Net Warehouse Facility 54,541.67 53%

Total Long Term Assets 60,646.17 59%

Total Assets 103,040.77 100%

Minimize and Turnover

Generate a Return

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Benchmark Your Performance Module 3

RMA (Risk Management Association) Annual Statement Studies – Financial Ratios

2017 Almanac of Business and Industrial Financial Ratios, 48th Edition

1. Know your NAICS Code: 448110 = Men’s Clothing Retail448120 = Women’s Clothing Retail448140 = Family Clothing Retail448150 = Clothing Accessories448210 = Shoes Retail448310 = Jewelry Retail

2. Know your size by total assets and total sales

1. Know your Industry Code: 315215 = Clothing Manufacturing448115 = Clothing Retail Store

2. Know your size by total assets and total sales

http://www.bizstats.com/

https://www.sba.gov/tools/sizeup

Two useful links:

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Exercise 2 – Let’s Calculate Some Ratios Module 3

Calculate two ratios per the Balance Sheet on this slide:

Current Ratio = Current Assets / Current Liabilities

Debt / Equity Ratio = Total Liabilities / Total Equity

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Exercise 2 – Benchmark our Ratios

Now let’s benchmark our calculations – refer to handout:1. NAICS Code = 4481202. Size of Business = Under $ 500,000 in Assets

Ratio Your Company(prior slide)

Industry Average

Current Ratio

Debt to Equity

Module 3

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Exercise 2 – More Benchmarking Module 3

Now let’s benchmark against the other source:1. Industry – We make clothing (Apparel Manufacturer)2. Size of Business = Under $ 500,000 in Assets

Type of RatioYour

CompanyIndustry Average

Current Ratio (current assets of $ 66,000 / current liabilities of $ 14,000)

4.7

Asset Turnover (Sales of $ 180,000 / Total Assets of $ 120,000)

1.5

Return on Assets (Net Income of $ 16,000 / $ 120,000)

13%

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Let’s Recap the first 3 Modules

1. Must have an accounting process to create financial statements2. Review financial statements at least quarterly – tax payments3. Current Assets must turnover and go through Cash quickly!4. Most businesses need a Gross Margin of 40% or higher5. Three techniques to analyze financial statements:

1. Ratios – One number in relation to another number per the financials

2. Horizontal – Trends over Time3. Vertical – Percentage breakdown of financials that can be

benchmarked

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Module 4

Additional Analysis

Some more important concepts related to financial analysis

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Direct vs. Indirect Cost Module 4

Sales Revenues (1,645 units sold x $ 26.00 Sales Price) . . . . . . . . . . . . . $ 42,770Less Direct Cost (1,645 units sold x $ 18.00 Unit Cost) . . . . . . . . . . . . . . . 29,610 Gross Profit or Margin . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13,160Less Indirect Cost:

Sales and Marketing Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . 2,350 Administrative Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3,450Rent and Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,780Insurance and Legal Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1,200Depreciation Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 900Other Miscellaneous Expenses . . . . . . . . . . . . . . . . . . . . . . . . . . . 760

Profit or (Loss) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ 2,720

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Variable (Direct) vs. Fixed (Indirect) Module 4

Variable Cost – Varies or changes with changes in sales. Includes production labor, raw materials and various discretionary items such as advertising.

Fixed Cost – Remains the same regardless of activity levels. Tends to be long-term commitments or non-discretionary items such as Rent, Insurance, Interest, Depreciation and Senior Management Salaries.

Sales Volume

CostVariable

Fixed

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Calculate Your Breakeven Point Module 4

Simple Concept: How much business do I have to do to breakeven (recover all of my costs)?

Breakeven Volume = Fixed Costs / (Sales Price – Variable Cost per Unit)

Breakeven Sales Amount = Fixed Costs / Contribution Margin Ratio

Contribution Margin Ratio = (Sales Price – Variable Cost) / Sales Price

EXAMPLE: Sales Price = $ 45.00 per shirt | Materials = $ 6.00 per shirt + Labor = $ 9 per shirt + Variable Overhead = $ 3 per shirt = Total Variable Cost per Unit of $ 18.00

$ 70,470 of costs are incurred no matter how much you sell

Breakeven Units = $ 70,470 / ($ 45.00 - $ 18.00) = 2,610 shirts must be sold

Contribution Margin = $ 27.00 / $ 45.00 = 60%

Breakeven Revenues = $ 70,470 / .60 = $ 117,450 (2,610 units x $ 45.00)

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What is Your Rate of Return? Module 4

Residual Benefits *

Total Amount Invested **ROI

Net Income

Average Equity for the Year

* Total Benefits less Total Amount Invested

** All costs to place the asset into service

What is the overall return the

owner is getting back from the

investment made in the

business?

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Quantify Benefits – Subjective Exercise Module 4

Organizational Benefits

Builds company reputation

Creates new customer opportunitiesFosters company vision and missionImproves market position relative to competitorsImproves the ability to serve customersIncreases competitiveness

Financial Benefits Creates additional/new revenueCreates cost savings through tax avoidanceEnables cost avoidanceFaster return on investmentsIncreases cash flowIncreases profitability of existing products/servicesIncreases revenue of existing sourcesIncreases stock price/shareholder valueLowers cost of productionLowers cost of servicing

Operational BenefitsDecreases employee work loads for undesirable workEliminates non-value added activitiesImproves employee morale / team spiritImproves internal communicationImproves use of workspaceReduces cycle timeReduces cycle time of production/processReduces external inputs to processesReduces person-hoursReduces process steps

Information Technology BenefitsDecreases maintenance/support costsImproves application/system performanceImproves application/system utilization rateIncreases efficiency of support activitiesIncreases productivity through automationReduces paper documentation requirementsStrengthens application/system security

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Example: Calculate Return on Investment Module 4

Proposed new marketing program cost $ 200,000. It will give the company much more exposure to new potential customers. Past programs have proven to increase a company’s revenues by 5% over a three year period. What is the Rate of Return for this investment?

Step 1 - Quantify the Benefits: Estimated Annual Revenues (next 3 years) are $ 1,600,000 x 5% = $ 80,000 benefits per year x 3 years = $ 240,000 Total Benefits (NOTE: Conservative Estimates are best used on the Benefit Side – Subjective and prone to error)

Step 2 – Quantify all of the Costs: Total investment cost is up front, one time fee of $ 200,000

Step 3 – Calculate the ROI: Total Benefits of $ 240,000 - $ 200,000 costs = $ 40,000 residual benefits divided by $ 200,000 = 20% ROI

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ROI must exceed Cost to Finance Module 4

All businesses have a cost of financing the business:

1. Cost of Debt – Interest Payments on Loans

2. Cost of Equity – Owners expect to get a return on what they’ve invested into the business

Cost of FinancingCreate Value

Destroy Value

Returns on Investment (ROI) destroy value

10%

12%

14%

16%

8%

6%

Returns on Investment (ROI) increase value

57

Exercise 3 – What is the ROI? Module 4

You are thinking about investing in a new vehicle to improve sales delivery for your food business. The initial investment required is $ 23,450 and you do expect some operating cost each year of about $ 3,150 per year for paying the driver, insurance, gas, and repairs. You have estimated that the delivery of food could really boost your sales each year over the next 5 years as follows:

Year 1 - Increase in Sales $5,000 Year 2 - Increase in Sales $7,500 Year 3 - Increase in Sales $9,500 Year 4 - Increase in Sales $11,000 Year 5 - Increase in Sales $10,000

Add up all the money you have to pay out – Day 1 investment + all the cost each year. Compare to the total benefits (Sales). What is the residual benefit?Divide the Residual Benefit by the Total Investment = Return on Investment

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Module 5

Evaluating Long Term Investments

How to evaluate the economics of long term investments (3 year

lease, 5 year vehicle, 10 year equipment, etc.)

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Distinguish Accounting vs. Finance Module 5

Accounting Finance

Historical Value (Looks Back) Future Values (Looks Forward)

Input = Transactions Input = Financial Statements, Estimates,

Analysis

Output = Financial Statements Output = Forecasts, Budgets, etc.

Not Analytical (Process Transactions) Very Analytical

Advocates Profits Advocates Creating Value

Enforce Rules and Comply Few Rules / More Creative

Short Term Focus Long Term Focus

60

Different Types of Value Module 5

Accounting

Historical

Values

Constant Dollars –

does not change

over time

Finance

Present

Values

What is the value

today?

Future

Values

What is the value

tomorrow?

Why the differences in value (Accounting vs. Finance)?

1. Risk – I promise to pay you $ 100,000 five years from now!

2. Inflation - $ 100,000 five years from now will lose purchasing power!

3. Opportunity Cost – If you had $ 100,000 now (not five years from now), you could do something with it – lost opportunity!

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Three Economic Criteria Module 5

1. Return on Investment – We discussed this earlier > Investors must earn a rate higher than the cost of capital; otherwise the investment is not.

2. Net Present Value – Discount the cash flows of both the costs and the benefits of the investment. The more positive the value, the more attractive the investment.

3. Discounted Payback Period – How long does it take for the investor to recover his investment. The shorter the payback, the more attractive the investment.

Three important economic indicators in finance for evaluating long term investments:

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Discounting the Future to Present Value

Three Important Steps:1. Identify the cash inflows (benefits) and cash outflows (costs) over the useful life of the

investment2. Identify your cost of capital3. Discount the cash inflows and outflows using your cost of capital

Module 5

i = 8% Year 1 Year 2 Year 3 Totals

Inflows $ 120,000 $ 84,000 $ 36,000 $ 240,000

Outflows $ (200,000) $ - 0 - $ - 0 - $ (200,000)

Difference $ (80,000) $ 84,000 $ 36,000 $ 40,000

Discount .9259 .8573 .7938

Present Value $ ( 74,072) $ 72,013 $ 28,576 $ 26,517

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When do we reach Payback? Module 5

Net

Present Cumulative

Year Value Value

1 (74,072)$ (74,072)$

2 72,013$ (2,059)$

3 28,576$ 26,517$

You reach pay back in Year 3 for this investment

A simple economic indicator – when will I recover all of my costs? Go back to the previous slide – net present values:

64

Example 4: Evaluate the Investment Module 5

Let’s go back to our ROI example, but this time we will take into account “time value” to come up with a more accurate analysis.

For all long term investments, try and document and forecast out both the cost and benefits of the investment over its useful life.

Once we know the cost and benefits, discount the amounts to reflect risk.

A positive Net Present Value indicates that this investment adds value. A negative Net Present Value indicates that the investment destroys value within the business.

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Take a Break

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Module 6

Advanced Concepts in Finance

Some advanced concepts in finance that can be important for any

sized business

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Manage Your Cash Flow Module 6

1. Put Emphasis on Selling – Sales cures all and you must capture customers and convert them

into sales to generate cash flow.

2. Forecast your cash inflows and outflows based on past history or what you expect to incur

month to month

3. Be aggressive in collecting money owed to you

4. Be aggressive in reducing your cash expenses:

a. Labor – Use temporary or part-time workers unless you can justify full time employees

b. Office – Use your home or shared office spaces as opposed to a formal expensive office

c. Purchases – Buy used as opposed to new and purchase only minimum quantities until

you can justify larger quantities

d. Insurance – Don’t over-insure the business, accept the risk until you can afford complete

insurance coverage

e. Bootstrap – Use free resources as much as possible such as social media for marketing

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The ROI Model (Exercise 5) Module 6

Return on Equity

(H)

Total Assets to

Total Equity

(G)

Return on

Investment

(F)

Profit MarginTotal Asset

Turnover

(D) (E)

Net Income Sales Total Assets

(A) (B) (C)

Let’s walk through Exercise 5 and fill this out

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What is a Sustainable Growth Rate? Module 6

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Is the Business Bankrupt? (Z Score) Module 6

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Understand Margins or Profits by Segment Module 6

Product ID

Project ID

Customer ID

Sales Revenues associated with the Product and all cost to make and deliver the Product to the Customer

Sales Revenues associated with the Project and all cost (billable / nonbillable) charged to the Project

Sales Revenues associated with the Customer and all cost to get the product or service to the Customer

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Example of Segment Reporting by Location Module 6

Store A Store B Store C Store D

Sales 100% 100% 100% 100%

Cost of Goods Sold 46% 51% 42% 55%

Gross Margin 54% 49% 58% 45%

Operating Expenses 34% 27% 36% 31%

Operating Margin 20% 22% 22% 14%

Non Operating Expenses 7% 7% 9% 11%

Profit Margin 13% 15% 13% 3%

Store D lags behind the other stores –

looks like they have a higher Cost of

Goods Sold. Store D needs to take a look

at how the other stores are keeping their

cost of goods down (better suppliers).

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Quarterly Sales by Customer Type Module 6

Quarterly Sales Summarized by Type

Customer Type 2016-Q1 2016-Q2 2016-Q3 2016-Q4

Young Women (under 30) 1,159$ 1,089$ 965$ 1,105$

Young Men (under 30) 905$ 1,106$ 875$ 982$

Mid Women (31 - 55) 2,605$ 2,560$ 2,678$ 2,811$

Mid Men (31 - 55) 1,230$ 1,289$ 1,246$ 1,328$

Older Women (> 55) 633$ 606$ 584$ 621$

Older Men (>55) 455$ 460$ 403$ 479$

Critical

group that

drives

Revenues

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Bad Approach to Cost Control Module 6

General Ledger Account Balances

Year End Expense Accounts

Account Description Balance

4001 Cost of Goods Sold * 3,166,401.50

4003 Marketing & Promotion 377,560.00

4005 Salary Expense 474,906.82

4006 Payroll Tax Expense 86,089.15

4007 Equipment Maintenance 36,450.92

4009 Rent & Lease Expense 19,807.65

4011 Utilities Expense 11,050.86

4012 Insurance Expense 7,650.00

4014 Product Warranty Expense 6,672.00

4015 Depreciation Expense 22,880.00

4016 Interest Expense 26,404.20

4017 Tax Expense 101,678.89

Total Expenses 4,337,551.99

* consists of direct materials + direct labor + allocation of overhead

It is not a good

idea to look at

your Income

Statement

accounts and just

decide to cut cost

based on this

information

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Better Approach is to Reduce the Work Module 6

• Eliminate non-value added type activities (“Re” type activities)

• Compress hand-off’s in workflows

• Look for delays, wait times, waste, defects, holding inventory, etc.

• Too many manual processes – invest in technologies

• Look at how people spend their time –should be spent servicing an internal or external customer

KEY POINT: Put emphasis

on managing the process

so it takes less time to

accomplish things.

Once you reduce time, you

no longer require as much

resources or people and

then you can reduce the

resource requirements now

that the work is gone.

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How much is your business worth? Module 6

Earnings or Net Income $ 1,850

Interest Expense (1) + 300

Taxes (1) + 420

Depreciation (2) + 160

Amortization (2) + 70

Earnings Before Interest Taxes

Depreciation Amortization or

EBITDA

$ 2,800

(1)Not directly related to the actual operations of the business

(2)Not an actual disbursement of cash

Most businesses get

assigned value based on a

multiple of their EBITDA

number which comes off

the Income Statement

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Exercise 5 –Value or Worth Module 6

Referring to the Income Statement to the left and with the assumption that a business of your size and your industry typically sells for 4 times its EBITDA number, what is your business worth?

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Intellectual Capital (IC) Module 6

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Measure and Grow Your IC Module 6

Major IC

Category

IC Description Measure to Grow

(Appreciate IC)

Human Capital Value of a business that is

contained in the skills, abilities

and talents of its people.

Level of Competency,

Level of Experience,

Advanced Certifications

Organizational

Capital

Value of a business that is

contained in the processes,

systems, patents, trademarks,

reputation, innovation, etc.

Process Turn Around

Times, % of Innovative

Ideas Implemented, # of

Patents Licensed, etc.

Relational Capital Value of a business contained in

its relationships with customers,

suppliers, other businesses,

government, etc.

Customer Retention

Rate, Satisfaction

Surveys, Supply Chain

Metrics with Vendors,

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Let’s Recap Key Points Module 6

1. Once you understand Ratios, you can leverage this approach through Ratio Models to gain key insights on how to run the business.a. How many days do I have to finance the business?b. What is a sustainable growth rate for the business?c. Is this business bankrupt?

2. Segment your Customers, Products, Projects – What segment is the most and least profitable?

3. Cut cost through elimination of work, not the workers. Time is what drives cost – how can we do this with less effort?

4. All business owners should have some grounding in how their business gets Valued. This is your basis for Retirement!

5. Intellectual Capital is now critical to increasing the value of most businesses

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Module 7

Analyzing the Business

There are a wide range of analytical models that you can use to help

you analyze your business

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It’s all about Solving Problems Module 7

What are the most important issues? Pareto Analysis

How does my industry work?

What is our current situation?

What performance areas are weak?

Porter’s Five Forces

SWOT

Benchmarking

How well do we manage our products / services? Boston Growth Matrix

GE Business ScreenHow well do we manage our different businesses?

What is causing this problem? Root Cause Analysis

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Ask Why Several Times Module 7

KEY POINT: In order to

get to the root cause of a

problem, you often have

to ask Why several times

It may take up to 5 times

or more to finally

understand the root

cause of your problem

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Example of Root Cause (YouTube Video) Module 7

The Jefferson Memorial explains how you have to be persistent in getting to the root cause of a problem:

https://www.youtube.com/watch?v=BEQvq99PZwo

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Most Popular Model: SWOT Module 7

Client has a global infrastructure to

service all types of customers

Strengths Weaknesses

Services are in high demand in most

parts of the world

Client has limited resources for

expanding its global reach

Untapped demand exists in almost half

of the World

New Technologies make it possible to

expand service reach

Other clients are investing in newer

technologies

Some clients are entering into strategic

partnerships to expand their global

footprint

ThreatsOpportunities

A very good instructional video: https://www.youtube.com/watch?v=I_6AVRGLXGA

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Know Your Industry: Porters 5 Forces Module 7

If you want to fully understand your industry, look at five different forces that define your industry:

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Example of 5 Forces: Fast Food Industry Module 7

MCD =

McDonalds

which has

strong brand

recognition – so

it’s not easy to

substitute, but

the competition

is very intense

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Categorize Products – Boston Matrix Module 7

1. Stars – Products with high growth rates and strong market position. Want to invest heavily and grow these aggressively.

2. Question Marks – Products with high growth rates, but market share is small. Invest heavily, but monitor closely to see if you can secure solid market share. Goal is to move these to the Star category.

3. Cash Cows – Products are mature and not growing, but they have a very secure and steady market. Invest modestly to sustain.

4. Dogs – Products with low market share and very low growth. Hard to sustain –Unless you can grow and improve, you should divest and remove these products.

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Example of Boston Matrix: Nestle Module 7

Forces every company to

re-think its product mix.

Not all products perform

the same. Depending

upon where you fall in

the matrix, this becomes

your strategy for how to

re-position your product

mix

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The 80 / 20 Rule: Helps You Prioritize Module 7

20% of your Customers

account for 80% of the

Volume

Focus on what matters

most and not the entire

100%

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Exercise 6: Where should we focus? Module 7

We have limited

resources to solve our

problems, where

should we focus first?

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Key Points and Approach Module 7

1. Be Proactive – Solve your problems BEFORE it shows up on the financial statements. This requires a very analytical approach to running the business.

2. Three Step Process:1. Define the Problem2. Select the right Analytical Model3. Apply the Analytical Model

3. Non Financial Parts (Customer, Processes, etc.) drive financial results. Don’t just measure financial results – measure your non financial parts. Examples:

1. Customer Satisfaction Survey2. Process Efficiency3. Product Quality4. Employee Turnover Rate

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Wrap Up and Summarize

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Summarize Workshop

1. Someone must keep the books – you must do accounting to understand if you are losing or making money.

2. Generate and review your financial statements on a monthly or quarterly basis3. Analyze the financial statements with ratios, horizontal and vertical analysis – be

analytical in how you look at numbers4. Current Assets must turn over and go through cash5. Long Term Assets must generate a Return greater than the cost to finance the

investment6. Benchmark the financials to evaluate your financial performance according to your

industry (NAICS) code7. Evaluate your long term investments – does it generate benefits greater than the cost

and if the life cycle is several years, consider discounting at the cost of financing or required return to see what the investment is worth to the business. This is what big companies do when they make major investment decisions.

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Summarize Workshop - continued

8. You can leverage the use of ratios within certain models to help manage key financial goals

9. It is helpful to assess profits by key segments of the business such as products, customers, locations, etc.

10. Business owners should ultimately try and increase the value of the business. Value is determined based on a benefit stream such as EBITDA with a multiple applied.

11. Increasingly it is the Intellectual Capital of the business that drives performance and value.

12. You can solve a wide range of business problems through the application of analytical models such as SWOT, Pareto Analysis, and Root Cause Analysis.

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A Few Useful Links

Finance and Accounting Seminars > https://www.seminarinformation.com/search.cfm?tp=7Teach Me Finance > http://www.teachmefinance.com/Finance World > http://web.utk.edu/~jwachowi/wacho_world.htmlStudy Finance > http://www.studyfinance.com/Principles of Finance > http://educ.jmu.edu//%7Edrakepp/principles/

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Contact Information

Matt Evans, SCORE Mentor

Email: matt.evans@scorevolunteer.org

Appointments: https://score-silver-spring-library.as.me/schedule.php

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